Ratio of Reward to Risk

To improve your chances of profit, trade when you have a possibility to make three times more money than you're risking.

You have a much better possibility of making money in the long run if you assign yourself a three ratio one reward-to-risk ratio.

Here is an example:

You can see that even if you only won 50 percent of your trades, you would still make a $10,000 profit in this case.

Just keep in mind that when you trade with a strong risk-to-reward ratio, your chances of making money are considerably higher, even if your win rate is lower.

BUT, this is a big one, having a high reward-to-risk ratio has a cost.

On the surface, the concept of a high reward-to-risk ratio sounds appealing, but think through how it works in real-world trading settings.

Believe you're a scalper who only wants to risk 3 pips.

With a reward-to-risk ratio of three ratio one, you'll need to collect 9 pips. The odds are stacked against you right away since you have to pay the spread.

If your broker only gave a 2 pip spread on EUR/USD, you'll have to gain 11 pips instead, pushing you to accept a risk-reward ratio of four ratio one.

You'd be stopped out faster than you could say “Uncle!” because the EUR/USD exchange rate can fluctuate three pips up and down in a matter of seconds.

If you reduce the size of your trade, you can expand your stop to keep your favorite reward/risk ratio.

If you upped the number of pips you intended to stake to 50, you'd have to gain 153.

By doing so, you'll be able to get your reward-to-risk ratio closer to the targeted 3:1. Isn't it a lot better now？

Reward-to-risk ratios aren't set in stone in the actual world. Depending on the time frame, trading environment, and entry/exit points, they must be changed.

A position trader's reward-to-risk ratio could be as high as 10:1, while a scalper's could be as low as 0.7:1.