What is this and why is it important to me?

Well, as the name implies, it is simply the ratio between the amount of money I am risking and the amount of money I could potentially earn. How do you know how much you will lose or earn? That is determined by your entry, stop loss and take profit levels.

**Click here**if for more information about them.

Lets take the

**most recent shorting opportunity**that I have identified as an example.

So how do we go about calculating the RRR?

1) We first calculate in

**absolute**value of the potential loss.

$35.72 - $37.66 = $1.94

2) Then, we calculate the absolute value of the potential gain.

$32.64 - $35.72 = $3.08

3) Finally, we divide the potential gain with the potential loss.

$3.08/$1.94 = 1.587

So what does this figure mean?

Basically, for every $1 we are risking, there is a potential to earn $1.59. The higher the RRR ratio, the better. Everyone will have their own predefined level that they are comfortable with. Some might prefer a RRR ratio of 1.5 and above.

But a good rule of thumb is to avoid those that are below 1. It does not really make sense to risk $1 to potentially earn $0.60. We want our risk to be justified.

I hope this has helped you understand what the Risk Reward Ratio is all about.

What are your thoughts about RRR? Leave them in the comments below!

As always, happy trading.

Cheers.

Hi

ReplyDeleteWhat about taking in the projected probability ratio for the gain and loss to come up with the ratio?

Hi B,

DeleteI've never heard of projected probability ratio. Could you explain it to me?

Regards,

Sgtrader92

Hi,

ReplyDeleteI think B means the expected value of your trade. Multiply the projected probability of the gains and losses and find out if that number is + or - ve.

If u know that the probability of winning $1 is 90% vs the probability of losing $2 is 10%, you can still come out profitably. But I don't think we can find out the probability of winning or losing, unless you have a huge data to rely on for a particular setup of a trade lol

Hi,

DeleteAhh, I think I get you now. It makes sense, but like what you said, I don't know how you would get such probabilities. Haha