Base your calculations of Risk and Reward on INITIAL conditions at the time you enter your trade. Those are your estimates of
(1) maximum acceptable loss, represented by your initial stop loss, and (2) potential profit, represented by your initial take-profit point.
In other words, R:R calculations ignore changes to your SL or TP after the trade is underway. Those changes (when they occur) are referred to as trade management, and they include: manually adjusting your stop, trailing your stop, adjusting your TP, and selectively closing a portion of your position.
A R:R ratio represents your plan, made before you enter your trade. In the simplest kind of trade, your actual results might match your calculated R:R ratio. Here’s an example. You enter the same type of trade every time, including a 20-pip SL and a 30-pip TP. You never intervene in your trade. Instead, you let it run until either your SL or your TP takes you out. Clearly, in this example, all of your trades will produce either 20-pip losses, or 30-pip profits; and all of your losses and profits will exactly reflect your initial R:R ratio.
In actual trading, this is rarely the case. Trade-management actions change the actual losses and profits you end up with. It’s a good idea to analyze these actual results from time to time, but it’s a tedious task requiring some time and some math.
In order to compare your actual trading results to your intended Risk:Reward ratio, you have to determine your average loss, and your average profit, over a certain period of time. Print out a copy of your broker’s statement showing every trade you made. Isolate the time period you want to analyze — say, the previous month. Cross out all the break-even trades. Total all the losing trades, and calculate the average of these losers. Total all the profitable trades, and calculate the average of these winners. You now have two averages. Divide the larger one by the smaller one, and write the result as a ratio. You can now compare this ratio of actual results to your initial Risk:Reward ratio.
Example: you had 16 losses totalling 360 pips, and 25 winners totalling 730 pips. Your average loser was 360/16 = 22.5 pips. Your average winner was 730/25 = 29.2 pips. Dividing these two averages, 29.2/22.5 = 1.3, so your actual results were
average loser : average winner = 1 : 1.3 over the past month.
Note that it’s common practice to refer to a risk:reward ratio, not a reward:risk ratio. And I have kept things in that order in the examples above.
Correct. 60% or your trades would have to be winners, in order to break even overall, [B]in theory[/B]. But, as was shown above, your actual results may be different from your intended R:R ratio.
For the algebraically inclined, here is the math.
Let W = % winners.
Then, (W)(0.67) - (1-W)(1) = 0 (break-even)
0.67W - 1 + W = 0
1.67W = 1
So, W = 1/1.67 = 0.5988 = 60% (rounded off)
