Risk:Reward explained

watch this video to learn how proper Risk Reward can help you earn more…

The win rate in trading it completely irrelevant on its own. Many traders put way too much emphasis on the win rate and do not understand that a win rate does not tell you anything about the quality of a system or a trader.

You can lose money with a 80% or even with a 90% win rate if your few losers are so big that they wipe out your winners. On the other hand, you can have a profitable system even with a win rate of 50%, 40% or only 30% if you are good at letting winners run and cutting losses short.

It all comes down to your reward risk ratio.

The reward to risk ratio (RRR, or reward risk ratio) is maybe the most important metric in trading and a trader who understands the RRR can improve his chances of becoming profitable.

You often read that traders say the reward-risk ratio is useless which couldn’t be further from the truth. When you use the RRR in combination with other trading metrics (such as win rate), it quickly becomes one of the most powerful trading tools.

Let’s say the distance between your entry and stop loss is 50 points and the distance between the entry and your take profit is 100 points .

Then the reward risk ratio is 2:1 because 100/50 = 2.

Why is this important? Because if you take trades that have a small RRR you will lose money over the long term, even if you think you find good trades.When you know the reward:risk ratio for your trade, you can easily calculate the minimum required win rate.

Minimum Win-rate = 1 / (1 + Reward:Risk)

If you enter a trade with a 1:1 reward:risk ratio, your overall win-rate has to be greater than 50% to be a profitable trader:

1 / (1+1) = 0.5 = 50%

Traders who understand this connection can quickly see that you neither need an extremely high win rate nor a large reward:risk ratio to make money as a trader. As long as your reward:risk ratio and your historical win rate match, your trading will provide a positive expectancy.

One of the greatest traders has said
“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”  – George Soros

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