How do you compute risk:reward ratio?

Beginner Questions
1

Hi guys,

Another newbie question.

I read about risk:reward ratios everywhere but I can’t figure out how to actually compute one for a given trade.

For example, say I want to enter a trade on the EURUSD currency pair with a risk:reward ratio of 1:3 (or 3:1 - which direction does it go? - either way, I mean higher reward than risk). I have an account with $1,000 margin available (brand new account - no other trades of any kind made yet - just to keep everything nice and simple).

I want to risk 1 micro lot. So I enter the market at 1.4740 with an $100 (1 micro lot) buy and the expectation that the market will rise.

How do I compute the risk:reward ratio on this trade?

Am I missing numbers need for the computation? What other numbers do I need to complete the computation?

Once I can figure out the full equation, I think I’ll have a much better understanding of how this works.

Much thanks!

  • Iggy
2

I think you’ve overanalyzed the situation a tad bit. When I refer to keeping Risk:Reward at 1:2 or above I just mean in your example, you enter at at 1.4740 using a -20 pip stop or a stop at 1.4720. To keep my 1:2 ratio that means I need to target taking profit at 1.4780 (+40pips from entry) or above.

Then I will have made twice what I have risked on that trade.

3

You need to know your stop. Say its 20 pips plus spread of say 2. Whatever your lots size you now have a maximum loss of 22 pips. This is equal to R. If your profit target for the whole contract is 44 and you make it then this is a 2R trade ie risk reward ratio is 2 because you made twice what you risked

Addit - just read Daedalus’ response, dont forget to factor in spread and commissions into your risk equation

4

Thanks daedalus and Tony. I appreciate the responses.

I’m making this harder than it is. You’ve regrounded me.

One more quick question:

I know at this point to always know where my stop loss is for each trade. Do you guys always have a profit target for each trade before entering into the trade?

5

In a word yes. For some models I trade it is not changeable (for instance the MACD contrarian). When I am trading price action then there will be specific areas I am targeting to get to based on support/resistance. If you think about it you must have this before you enter a trade so you can know its worthwhile. Put simply if you were risking a 100 pips and the next logical failure point was 10 pips away why would take the trade

6

Ah, thanks Tony. That’s the missing piece of the puzzle for me. Got it.

OK, back to my studies. Much thanks!