How to use Risk Reward Ratio in Trading

Beginner Questions
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Trading risk management refers to a structured approach designed to limit losses while maximizing potential returns. Traders rely on various tools and principles to safeguard their capital and manage their accounts efficiently.

Among these tools, one of the simplest yet most powerful is the risk‑reward ratio.

The risk‑reward ratio measures the potential profit of a trade (or a trading period such as a day, week, or month) relative to the potential loss. In essence, it helps define how much risk you are willing to take in a single trade or within a trading session—making it especially valuable for day traders.

For instance, using a 2:1 risk‑reward ratio means you are prepared to risk $1 in order to target a $2 profit on each trade

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Helloooo! :blush: I think it would also be more interesting if you can also show a bit of your trading and how you use these things you’re sharing. :smiley:

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Sure why not… I would like to share the things of mine… Being an author I would love to do that

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Interesting! :blush: Now I look forward to what you have to say even more! :smiley: Thank youuuuu!

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You actually have that the wrong way round.

If you have a 2:1 risk-reward it means you’re risking 2 units to win 1.

If you’re risking 1 unit to try to win 2, as you describe, that’s (naturally enough) called a 1:2 risk-reward, because it’s 1-risk and 2-reward. :slight_smile:

By the way, this widespread point of confusion’s been discussed here many times! These threads will help anyone interested. :wink:

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with RR it is all about getting assymetic bets…to bet small, but win way more…that is how money is made

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Sadly, it isn’t possible, in forums, to stop people repeating this very widespread misinformation, deeply mistaken though it is. :roll_eyes:

I’d hoped that the 6 links in my post just above (pro-traders’ views) might help, but I think many people prefer to have their own beliefs reinforced, rather than looking at any expert opinion and being open to the possibility of learning something. :unamused:

In professional trading circles, an R of around 0.7 to 0.75 is considered “normal,” and serious variances from that kind of figure are few and far-between, with 1.0 being regarded as the maximum.

But for some reason, it sometimes seems that many people in forums really don’t like hearing this.

In forums, many people like (and advise) risk to reward of 1:2 or even more.

In the real world - as anyone who has ever worked for a broker will tell you - brokers identify customers who trade with a risk-to-reward much above 1:1 and will almost never pass their trades to any kind of liquidity provider or lay off their risk, because decades-long experience has taught them that 100% of those customers will lose, in the long run, so they’re naturally very happy to be the counterparty. This is how brokers make a living. Not from the spread, as they’d like you to imagine.

Among prop firm customers doing evaluations, the average risk-to-reward is 1:2+, but among the far smaller proportion of people actually passing them, it’s about 1:1.

But we all decide for ourselves whose advice we choose to listen to. :neutral_face:

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Good catch. I see people flip the wording all the time. I just say “I’m risking X to make Y” so there’s zero confusion.

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Good idea - thank you, and welcome to Babypips! :+1: :sunglasses:

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None of this Risk/Reward makes any sense.
RISK YES, makes plenty of sense it’s the only thing you can control, but reward? How do you know, without a crystal ball, how much the market will give you?

I think the ONLY justification for TP is if you can’t be at your screen.

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I agree with you if you look at Risk/Reward in isolation of other measures.

R:R is meaningless without also considering win rate, for example. If one’s strategy is based on a R:R of 1:1 then you know you also need a win rate in excess of 50% to generate an overall net gain.

Also, as you say, one cannot predict where price is going to reach. But neither should a stoploss level be based just on arithmetic whilst ignoring suitable levels where a stoploss order would be more sensible.

We design our strategies according to the price action characteristics of the instrument we select, the timeframe we use, the indicators and/or PA we prefer, and the size of our wallet, etc.

The strategy itself then defines the typical size of moves we are looking for and the distance to stoplosses that, if reached, would nullify the basis for having entered the trade.

When we define these two extremes we can then decide if the trade makes sense in R:R proportions.

On shorter timeframes, like 4H, 1H, and less, the R:R ratios defined by the strategy employed will probably be typically similar across all trades. For example, I doubt many people using 15min charts hold positions for several days.

So I would suggest that it is more the chosen strategy, and its overall win rate that defines the resultant typical R:R rather than using a pre-selected R:R to define the trades?

For example, I trade mainly off 1-hour charts with a win rate generally in the 65-75%range and the trades generated by my strategy typically have TPs and SLs defined by nearby S/R zones that inevitably form an R:R of around 1:1.

Afterall, if one looks for, say, an R:R of 1:4 on a 1-hour chart, then it will rarely succeed and the win rate will be very low. If, on the other hand, the TPs are sensible but the SL’s are too far away, say, 4:1, then the occasional hit on the SL will wipe out a lot of profit even though the win rate is fairly high.

Just some thoughts

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I think a component that is often overlooked when dealing with risk reward ratios is a consistent dollar amount of risk.

Trade 1: I risk $100 to make $200 and win so I’m up $200,
Trade 2: I risk $200 to make $400 and lose, so I’m back to $0 profit.

By only counting Rs gained or lost, I would technically be up +1R, but my account balance wouldn’t reflect this benefit since the dollar value of 1R wasn’t consistent across trades.

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Yes - TOTALLY MEANINGLESS GARBAGE

This drives me mad!
I come from a successful horse race betting environment (in the 60s/70s when you could get a decent bet on). This R:R is like saying 'This horse should be 4/1 but it’s 20/1 (damn good bet) but I’m not going to bet it ‘cos I only bet horses around 2/1’:roll_eyes:

And what about the cliche ‘Cut your losses and let your winners run’ ?

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Now, now, @Johnny1974, you are quoting me totally out of context! :wink:

I didn’t say R:R is meaningless per se, I said:

In other words, I think it does have relevance, but only together with other critical parameters like win rate and, as @MartialChartsFX so accurately points out above:

I doubt anyone would deny that some kind of risk management is essential for long term consistency. The question here is what role, if any, does R:R play in risk management.

As you rightly say, one should try to limit losses and maximise winners, but this should also be in the context of one’s strategy. For example, a position trader might run trades for weeks when following a trend and gain a huge R:R%. But a day trader is unlikely to see an intraday move of 1:5, for example, very often. So their end result will be a string of losses whilst hunting the elusive end of the rainbow today, which, unfortunately, is always beckoning from tomorrow! :upside_down_face:

And, of course, if one’s strategy is a trend follower using only a trailing stoploss then there is no R:R simply by definition because there is no TP. The final R:R is not achieved until the trailing stop is finally hit!

Two other trading styles which also don’t require a concrete R:R are:

  • Scaling in and out of position size as the price moves
  • Monitoring the trade and closing when suitable with only a mental SL area in mind, and setting a long-distance hard SL as an emergency, or “air bag” in case of flash crashes. In this case, the R:R is meaningless in a risk management sense.

Another reason why R:R is so limited as a sole risk indicator is that it only functions if one trades on a “set and forget” basis, leaving the trade to always hit one pre-set barrier or the other - and always with the same position size. But I would guess that the majority of traders actually monitor their trades and will often adjust the trade parameters (e.g. moving SL closer to entry or B/E) or closing the trade if it just falls short of the TP.

So I don’t think R:R is totally meaningless. But is not much use purely as an isolated ratio.

Every trade should make sense. This means that the potential reward one anticipates should be worthwhile relative to the loss one is risking. And that ratio is flexible and integral to the trading strategy one is employing.

It is not so complicated at all - and I am sure most traders come to perform that analysis almost intuitively without the need to apply mathematical calculations like 1:1.5? or 1:2?, no wait, maybe 1:0.75? No let’s go for broke with 1:20… :innocent:

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Sorry for quoting you out of context @SovoS

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No worries! We’re pretty much in the same camp on this issue anyway! :slight_smile:

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Optimize trading decisions using the risk reward ratio by setting disciplined stop loss and take profit levels, ensuring potential rewards consistently outweigh risks.

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I just use a 1:1 ratio, yeah, it sounds uncommon, but that’s what I do to make money on trading. In reality, 2:1 or even 3:1 never works, the market has become very volatile in recent years, so prices change quickly every day. It’s impossible to wait for a certain time to get to your take profit with a 3:1 risk ratio. Instead of that, I focus on real moves and short-term ideas, hitting stop-losses with this approach is likely low.