A risk:reward ratio can play an essential part inyour trading strategy, and ensure that you're not risking too much of your capital. This lesson teaches you howto use ratios effectively.
In this lesson you can learn:
- Why reward:risk probability is important in trading
- What are the most popular reward:risk ratios
- Why probability is the key to every trading strategy
A risk:reward ratio is utilised by many traders to compare the expected returns of a trade to the amount of risk undertaken to realise the profit. To calculate the risk:reward ratio, you need to divide the amount you stand to lose if the price moves in an unexpected direction (the risk) withthe amount of profit you expect to have made when you close your position (the reward).
Some of the most popular reward:risk ratios are 2:1, 3:1 and 4:1,and these will change depending on the strategy of the trade. Of course, there are other aspects which may affect the risk of a trade, such as money management and price volatility, but having a solid reward:risk ratio can play a strong role in helping you to manage your trades successfully.
Example of a Risk:Reward Ratio
Let’s say that you decide to go long on ABC shares. You ‘buy’ 100 lots, equivalent to 100 shares, which are priced at £20 for a total position value of £2,000 - on the basis that you believe the share price will reach £30. You set your stop loss at £15 to ensure that your losses do not exceed £500.
In this case then, you’re willing to risk £5 per share to make an expected return of £10 per share after closing your position. Since you’ve risked half the amount of your profit target, your reward:risk ratio is 2:1. If your profit target is £15 per share, your reward:risk ratio would be 3:1, and so on. Therefore, it’s possible that one profitable trade will cover two, three (or more) losing trades.
It’s important to remember,however, that while risk:reward ratios helps to manage your profitability, they don'tgive you any indication of probability.
The Importance of a Risk:reward Ratio
Most traders aim to not have a reward:risk ratio of less than 1:1, as otherwise their potential losses would be disproportionately higher than any likely profit, i.e. a high-risk trade. A positive reward:risk ratio such as 2:1 would dictate that your potential profit is larger than any potential loss, meaning that even if you suffer a losing trade, you only need one winning trade to make you a net profit.
Invest in Real Stocks & ETFs with 0% commission*For monthly turnover equivalent up to 100,000 EUR (then comm. 0.2%, min. 10 GBP)
Create your account in minutes
Below we have included a table thathighlights different reward:risk ratios and their impact on your total profits and losses. The table below assumes 1 is equal to £100 and you have a win rate of 50% across 10 trades.
You can see clearly from the table below the potential benefits of having a positive reward:risk ratio and how this can impact your net profitability.
Probability Is Key
Wementioned probability briefly above, but let’s take a more in-depth look.
Let’s say that out of your last 100 trades, 60 were profitable. That gives you - or your trading system - a probability score of 60%. Probability depends on your trading system, as well as on your emotional ability to stick to that system.
What’s more, the main objective of every analysis made ahead of entering the market is to maximise the chance of entering a high-probability trade. If you look for a specific technical pattern, you are trying to maximise a probability. Why? Because as it appears, it should be followed by a specific move of the price. By searching for a pattern you are potentially increasing your chances of finding a higher probability trade.
Choose the Right One for You
Each trader has their own trading strategy and risk-reward ratio that is the most suitable for them. One of the challenges of trading is finding a system that works for you and one that ‘fits’ your mindframe.
If we think about risk tolerance on a spectrum, where do you think you would be? Are you risk-averse, cautious and calculated? Or are you open to taking more risk and enjoy the adrenaline?
The most important thing is to choose a system of risks and rewards that is manageable for you, and that potentially increases the chances of your trading being as successful as possible. There’s no specific rule - you just have to find a perfect one that suits your strategy.
This content has been created by XTB S.A. This service is provided by XTB S.A., with its registered office in Warsaw, at Prosta 67, 00-838 Warsaw, Poland, entered in the register of entrepreneurs of the National Court Register (Krajowy Rejestr Sądowy) conducted by District Court for the Capital City of Warsaw, XII Commercial Division of the National Court Register under KRS number 0000217580, REGON number 015803782 and Tax Identification Number (NIP) 527-24-43-955, with the fully paid up share capital in the amount of PLN 5.869.181,75. XTB S.A. conducts brokerage activities on the basis of the license granted by Polish Securities and Exchange Commission on 8th November 2005 No. DDM-M-4021-57-1/2005 and is supervised by Polish Supervision Authority.
FAQs
In many cases, market strategists find the ideal risk/reward ratio for their investments to be approximately 1:3, or three units of expected return for every one unit of additional risk. Investors can manage risk/reward more directly through the use of stop-loss orders and derivatives such as put options.
What is the risk reward ratio in XTB? ›
To calculate the risk:reward ratio, you divide the amount you stand to lose if the price moves in an unexpected direction (the risk) by the amount of profit you expect to have made when you close your position (the reward.)
Is 2:1 risk reward good? ›
A positive reward:risk ratio such as 2:1 would dictate that your potential profit is larger than any potential loss, meaning that even if you suffer a losing trade, you only need one winning trade to make you a net profit.
What is the win rate for professional traders? ›
Winning 30 out of 100 is a 30% win rate. Most professional traders have a win rate near 50% or less. They are profitable because they make more on winning trades than they lose on losing trades.
What is the best risk reward ratio for scalping? ›
For any stock you plan to scalp, you must understand the price supports, resistances and the set-up. From there, you can calculate the share sizing and the probabilities versus the risk. In scalping, a 3:1 risk to reward ratio is common (although, lower risk/reward is always more favorable).
How many pips for stop loss? ›
The stop loss should be placed 15-20 pips above the sell order level. The take profit is 30-40 pips.
What is the safest leverage ratio? ›
The best leverage in forex markets depends on the investor. For conservative investors, or new ones, a low leverage ratio of 5:1/10:1 may be good. For seasoned investors, who are more risk-friendly, leverages may be as high as 50:1 or even 100:1 plus.
How to increase probability in trading? ›
That means looking at the risk to reward ratio before entering a trade, making sure that you have a large enough account to take the risk, and if you don't, stand aside and wait for a trade you can take. Risk management is a trader's secret weapon, and you must use is to survive over the long haul.
What is a 2 to 1 profit loss ratio? ›
The higher the number, the better the system is at predicting future price movements. Many investing books suggest a minimum of a 2:1 profit/loss ratio. As an example, a system with a win average of $800 and a loss average of 400$ over a defined time period would have a profit/loss ratio of 2:1.
Is 1.5 risk Reward good? ›
The 1.5 Risk-Reward Ratio: Balancing Risk and Reward
A commonly cited benchmark in trading is the 1.5 risk-reward ratio. This ratio suggests that for every unit of risk taken (usually measured as a percentage or dollar amount), an investor should aim for a potential reward that is one and a half times greater.
If you have a win percentage of 30% then to break even you would need your average winner to be 2.3 times the size of your average loser. (Risk/Reward = 2.3) Therefore, if your anticipated win percentage is 30% do not take any trade unless your potential risk/reward is larger than this.
What is 0.5 risk to reward? ›
The risk-to-reward ratio can be less than 0.3, but taking a higher risk reduces your chances of profit, whereas taking a lower risk does not always result in a decent profit. A maximum risk/reward ratio of 0.5 is recommended. With this ratio, you have a better chance of profitability.
Is 90% win rate possible in trading? ›
Any system with a 5 pip profit target and a 500 pip stoploss will have a very high (probably 90%+) win rate. But then one loss will ambush you. In other words, you need to consider the RR (return to risk ratio) of each trade, as well as the win rate.
Is 70% win rate good in trading? ›
The backtesting results of Macd/Bollinger Band, Moving Average, and Triple RSI trading strategies have shown promising results with a high win rate. A simple forex trading strategy with a 70%+ win rate can also be effective for traders.
What trading strategy has the highest win rate? ›
Overall, the strategy with the best results was the Reversal Candle Strategy. Both the 15-minute and 30-minute time frames performed well, but the 30-minute was the overall winner outperforming the asset by a whopping +18.14% over the time period we tested.
Is a 1.5 risk to reward ratio? ›
The 1.5 Risk-Reward Ratio: Balancing Risk and Reward
A commonly cited benchmark in trading is the 1.5 risk-reward ratio. This ratio suggests that for every unit of risk taken (usually measured as a percentage or dollar amount), an investor should aim for a potential reward that is one and a half times greater.
What is a good risk per trade? ›
Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters, your maximum loss would be $100 per trade.
Is a high win rate better than risk reward? ›
If you have a high win rate, your risk to reward can be lower. You are profitable with a 60% win rate and a risk-to-reward of 1. Now, you will have more profit with a 60% win rate and a high risk-to-reward ratio. If you have a win rate of 50% or less, your winning trades should be higher than your losing trades.
What is the risk reward ratio in trading view? ›
The risk/reward ratio measures the difference between the entry point to a stop-loss and a sell or take-profit point. Comparing these two provides the ratio of profit to loss, or reward to risk.
