The risk-reward ratio (RRR) measures the potential profit of a trade relative to its potential loss, helping traders evaluate whether a trade is worth taking. To calculate it, divide your expected profit (reward) by your potential loss (risk). For example, if you risk $100 to make $300, your RRR is 1:3.
Why It Matters
- Objective Decision-Making: Ensures trades have a favorable upside before entering.
- Long-Term Profitability: Even with a 50% win rate, a 1:2+ RRR can keep you profitable.
- Risk Management: Helps set logical stop-loss and take-profit levels.
How to Use It Effectively
1. Set Stop-Loss First: Determine your max acceptable loss (e.g., 2% of capital).
2. Define Reward Target: Aim for at least 2–3x your risk (e.g., 1:3 RRR).
3. Avoid Low-RRR Trades: A 1:1 ratio often requires >60% win rates to succeed.
By prioritizing high RRR trades, traders can lose less when wrong and earn more when right, creating a sustainable edge.