Think of making a trade with anything in life. Whether it be sports, the car dealership, or even buying something from the store (exchanging money with what you perceive its value is worth). When you’re trading something, you want something of equal or greater value. When it comes to the market, your risk is what you are willing to lose if your trade goes against you, whereas your reward is what you will gain if the trade goes in your favor.

A 1:1 Risk to Reward ratio means with this particular trade, you’re willing to lose the same amount you’re willing to gain. If your stop loss is set at -$50, your take profit is set at $50. If your stop loss is set at -$100, your take profit is set at $100. 1:1. This is the MINIMUM you should be trading with because if you used a R:R of anything less, it would be pointless. Would you trade DOWN for something? Would you trade your iPhone 12 for an iPhone 8? No. Make sure you’re not risking 90 pips, just to gain 30 pips. That’s backwards.

NOTE: With this R:R ratio, you HAVE to win more than 50% of your trades just to be slightly profitable, and more than 70-80% to be really profitable. The reason being is you’re losing what you’re making every time. So you HAVE to win 7 out of 10 trades, or 8 out of 10 trades, or 9 out of 10 trades. Doing so may be hard which is why most people like to have a higher R:R ratio.

A 1:2 R:R is the same thing. If your stop loss is set at -$50, your take profit is set at $100. If your stop loss is set at -$100, your take profit is set at $200. 1:2! The good thing about this is, even if you have to lose TWO TRADES, all you have to do is win one trade and you’re back at breakeven.

EXAMPLE:

R:R Ratio: 1:2.
SL: -$100
TP: $200

TRADE #1: LOSS -$100
TRADE #2: LOSS -$100
TRADE #3: WIN $200

PROFIT at the end of the week: $0. You broke even. In this scenario, you still would have to win close to 50% of the time to be profitable. 5 wins and 5 losses would look like this:

5 WINS at $200 = $1000.
5 LOSSES at $100 = -$500

PROFIT at the end of the week: $500.

You see! A higher R:R ratio allows some breathing room with your trading, even if you lose.

Using a 1:3 or higher is exactly the same. If you’re risking -$200, your goal is a reward of $600. 1:3! You only have to win one trade even if you lose 3 in a row!

EXAMPLE of a 1:3 R:R Ratio and you won 50% of the time.

5 WINS at $600 = $3000.
5 LOSSES at $-200 = -$1000.

PROFIT at the end of the week: $2000.

That in a nutshell is Risk-To-Reward Ratio. Now you see why it’s so important? Imagine if you won 70% of the time. It would be crazy!

NOTE: It’s not as easy as it sounds. Just like there are winning streaks, there are losing streaks, so you must always plan!

Now, we do have traders who take on trades with greater risk, than reward. If that sounds silly, it’s because it is.