March 19, 2023

Risk Reward Ratio Explained

Smart traders get rewarded for making and taking smart risks.

Unintelligent traders get punished for taking uncalculated risks.

Taking risks is needful but making and taking smart, well-calculated risk reward ratio explained in this article defines a smart trader.

Some traders use a 1:2 risk reward ratio and are still consistent losers.

Alternatively, few traders look for trades with a risk reward ratio of l.5:1 and yet remain profitable traders.

Is there a risk reward ratio calculator I can use to better my trading plan?

Is there a risk reward ratio formula I need to adapt to as a day trader?

Contents

## Understanding Risk Reward Ratio

In this post, I will explain the complete guide and mastery to risk reward ratio trading and risk trading.

How to define reward and set a good take profit

How to calculate risk reward ratio

What is the risk reward ratio?

The risk reward ratio is a ratio of what you intend to risk for a trade-in in comparison to the reward expected.

It can be calculated by dividing the difference between the price entry of a trade and the stop-loss order (i.e.the risk) by the difference between the price targeted profit and the price entry (the reward).

Meaning, the risk is divided by reward, and a ratio greater than 1 means a greater risk while a ratio less than 1 means a greater reward.

Risk reward ratio is not a holy grail strategy that day traders look to trade in isolation. A smart trader has the mastery of some other trading plan to better affect this strategy.

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A risk reward ratio of 1:3 means a risk of \$1 and a reward of \$3.

A risk reward ratio formula of 1:7 means a risk of \$1 to a targeted reward of \$7.

What is a good risk reward ratio? I would not give a direct answer to that question because there is really no ideal risk reward ratio.

Mathematically,

Taking a risk reward ratio of 1:3 does not guarantee success in trading.

How?

Risk reward ratio explained here pinpoint that analysis as thus:

By Calculation,

This implies that he lost 7 * 1 = \$7

And won 3 * 2 = \$6

Factoring out the difference shows he has lost \$1!

This tells us you need a winning trading plan and not just a risk reward ratio formula or a risk reward ratio calculator.

What is the trading risk to reward ratio? I would not like to go into risk reward ratio calculation because all of that those not guarantee a winning trade.

The most important and smart thing to do as a trader is to determine your high winning rate. For example, you should look to win at least 6 – 8 trades out of 10!

Getting 60% – 80% winning rates guarantees success and a profitable trading plan.

Risk reward thinking is the approach I advise my students, risk reward ratio theories and concepts from textbooks have been overused unnecessarily and they don’t work. These and some other conventional rules in forex should be aborted to have a successful trading plan.

## How to Set Risk Reward Ratio Explained

What is a risk return ratio? The risk return ratio is also the same explanation as to the risk reward ratio. A return is also your reward just have trading successively.

How do you trade differently and like a pro in the financial market?

First, you must think differently and not just like every other trader.

Having known that using a risk reward formula does not really guarantee winning rates, then you need to find out what factors guarantee winning rates.

### How do You Set a Good Stop Loss?

Stop loss is not just a position you set in trades without proper analysis and market structure. These market structures include:

Area of support and resistance (major support and resistance area or zones)

Using a trendline

Using the 50 SMA moving average to trail stop loss

But above all, your risk management must be well planned.

What lot size do you have to trade with?

How many pips must you be willing to risk?

For example:

Do not take more than 5 trades in a day until you become a pro in trading, that sums up to a risk of 5% of your equity daily.

When you have 3 losing trades, stay out of the market for the day.

Always give space for your entry and stop loss, allow good breathing space.

If allowing a good breathing space will cost you much more than using a risk reward ratio of 1:2, do not trade!

Never be intimidated by Fear of Missing Out (FOMO).

### How do You Set a Good Take Profit?

How to calculate risk reward ratio in trading is making a proper plan of your stop loss and take profit.

What is the trend of the market?

What is the supply and demand zone?

If the trend is a downtrend, at what point or points are buyers likely to pull the market up? Are you trading price action trends?

Where are the major support and resistance zones?

In a weak trend, supply zone, demand zone, support, or resistance areas are all price points where profit can be taken and you can watch the flow of the market.

Do not be greedy. Be the disciplined trader!

A smart swing trader would quickly get out of the market as soon as the directional swing ends in his particular time frame of consideration.

## Breaking The Edge Using a Risk Reward Trading

Having learned how to set a good stop loss and take profit from risk reward ratio explained. This will make you know the risk-reward ratio you’re using or that works best for you.

You have to experiment with as many trades as possible before you could have a winning strategy and a high winning rate.

At this juncture, I would recommend XM broker to you, so you would open a micro account with them for you to be able to use a good lot size while trading with as little as \$10.

When you trade trends, ensure your SL (stop loss is above the trend indicating a hit on your stop loss breaks the trend.

Conversely, when trading support and resistance, use an SL, where a hit on the SL guarantees broken support, and/ or resistance.

Be watchful of spikes in the market that appear to be a break of structure.

Always look out for price rejection at supply zones, demand zones, areas of support, and resistance.

## Conclusion

I have discussed how to make a smart trading plan and use it judiciously for your day trading.