What is risk reward Ratio?

Risk reward ratio is an important part of profitably trading. This is particularly true when it comes to swing trading. Put simply, your risk reward ratio is how much are you going to make if you’re right and how much are you going to lose if you’re wrong. For instance,if you are buying a stock that hits resistance at $30 and you would expect it to go up to $36. You would also place a stop at $32. The most you can lose on this trade is $3 and the most you can make is $10. This gives you a risk reward ratio of $6/$3 or 2/1.

Many experts agree that when you are swing trading you should have a risk reward ratio of at least 2/1. This way you can be wrong 66% of the time and still make a profit. If you were to use a 2 to 1 risk reward ratio being right only 34% of the time your average profit per trade would be (.34)*(4) or 1.36. Your average loss would be (.66)*(1) or .66. This means on average you would make 1.36 - .66 or .7. Since that number is positive you would make money on average with that system.

If you would like to see if a system is profitable, the risk reward ratio must be both taken into account. If you were right only 10% of the time with a 2/1 risk reward ratio you would have an average loss per trade. Also, if your risk reward was 1/1 and you were right 80% of the time you would still have a profitable system. To find out what risk reward factor you need to be profitable you must make a lot of paper trades. Personally, I will not take a swing trade under 3/1 but 2/1 seems to be the general rule.

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