The reward to risk ratio (RRR, or reward risk ratio) is maybe the most important metric in trading and a trader who understands the RRR can improve his chances of becoming profitable. Basically, the reward risk ratio measures the distance from your entry to your stop loss and your take profit order and then compares the two distances. Traders who understand this connection can quickly see that you neither need an extremely high winrate nor a large reward:risk ratio to make money as a trader. As long as your reward:risk ratio and your historical winrate match, your trading will provide a positive expectancy.
🔷 Calculating the RRR Let’s say the distance between your entry and stop loss is 50 points and the distance between the entry and your take profit is 100 points . Then the reward risk ratio is 2:1 because 100/50 = 2.
Reward Risk Ratio Formula RRR = (Take Profit – Entry ) / (Entry – Stop loss)
🔷 Minimum Winrate When you know the reward:risk ratio for your trade, you can easily calculate the minimum required winrate (see formula below). Why is this important? Because if you take trades that have a small RRR you will lose money over the long term, even if you think you find good trades.
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QuantVue
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@zAngus, Thank you! Glad we're able to provide value to the community. We'll continue to do so! 💪
SmashStocks
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Addition to this: The importance of keeping share size relatively the same for each trade, goes hand in hand with risk v reward ratio. E.g. you might select a 1:2 risk reward ratio and let’s say you risk losing $100 on each trade to make $200. After 2 winning trades you might become confident and decide to up the risk $500 to make $1000 but let’s say you lose that trade. Suddenly, all your profits are wiped away even though the risk reward ratio never changed but because you changed share size significantly and randomly. Hope that helps.
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