Risk reward ratio

The risk reward ratio is vital aspect to day and swing traders strategies. Combined with technical analysis strategies, it can lead to regular consistent profits.

The risk reward ratio applies to the stop loss point and the target (exit) point of a trade. The risk being the point you place your stop losses and the reward being the point at which you close your trade.

The golden rule of risk:reward is that from each trade your reward should be at least 3x your risk meaning the risk reward ratio should be at least 1:3. This is based on the theory that if only 33% of your trades are successfully then you will still make a profit.

Example

• Risk [1] $100 : Reward [3] $300 – trade loses – $100
• Risk [1] $100 : Reward [3] $300 – trade wins – $300
• Risk [1] $100 : Reward [3] $300 – trade loses – $100

This means in 3 trades only 33% are successful, but $100 profit is still made!

Ok, this is only a basic example but the theory works. This is a major benefit to a trading strategy, it means you don’t even have to be successful all of the time and your trades and still make a profit! If you trade regularly or want to trade regularly and don’t know about the risk reward ratio then I suggest looking at some stock market courses to improve/generate your strategies.

If you live in the UK, Knowledge To Action run a free seminar teaching you stock market basics and explain the risk:reward ratio in more detail, obviously they don’t give away all their secrets for free but having been on the course I recommend going along to the free taster seminar.