Learn Risk-Reward Ratio | Risk Management For Beginners
📚The risk-reward ratio (or risk return ratio) measures how much your potential reward (or return) is, for every dollar you risk.
📚For example:
If you have a risk-reward ratio of 1:3, it means you’re risking $1 to potentially make $3. If you have a risk-reward ratio of 1:5, it means you’re risking $1 to potentially make $5. You get my point.
⚠️Now, here’s the biggest lie you’ve been told about the risk reward ratio:
“You need a minimum of 1:2 risk reward ratio.”
This statement is incorrect! Because the risk-reward ratio is meaningless on its own.
📚Here’s an example:
Let’s say you have a risk reward ratio of 1:2 (for every trade you win, you make $2).
But, your winning rate is 20%. So out of 10 trades, you have 8 losing trades and 2 winners.
Let’s do the math…
Total Loss = $1 * 8 = -$8
Total Gain = $2 * 2 = $4
Net loss = -$4
By now I hope you understand the risk reward ratio by itself is a meaningless metric. Instead, you must combine your risk-reward ratio with your winning rate to know whether you’ll make money in the long run (otherwise known as your expectancy).
📍THEREFORE:
The key to success is the combination of the RR and Win Rate in such a fashion that yields a positive return.
📙Example:
🔘If your RR is 1:1 then you start making money with 51% win rate and above.
🔘If your RR is 1:1,5 then you start making money with 41% Win rate and above.
🔘If your RR is 1:2 then you start making money with 34% win rate and above.
🔴The higher the RR the lower is the breakeven Win Rate!
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