Risk reward ratio is the “holy grail” of trading. Negative and Positive risk reward ratios are what differentiates long term losers from professional money makers.
This is your bridge to profitability
Risk to reward ratio is not only a way of money management but the main way to realize profits in trading.
Many traders put way too much emphasis on the win rate and do not understand that a win rate does not tell you anything about the quality of a system or a trader.
When you know the risk reward (RR) ratio for your trading system, you can easily calculate the minimum required win rate.
Why a Positive Risk reward Ratio
Take a look at the table below;
Positive risk reward (RR) means more return on your investment as shown in the table.
The advantage here is that you can afford to take stop loss hits more than you think.
In fact, it’s possible to lose more than ½ your trades and still stay in profit, if you have the correct risk reward.
This is because your winning trades make up for any losing trades you may have accumulated.
So even with losing trades you can still build up your equity curve.
Negative RR ratio
A negative risk reward ratio means you are risking more and making too little. This is shown in the orange highlighted zone above.
This is the worst way to make money in any business.
In this case, you must have a very high win rate to stay profitable. This is one of the reasons most Forex traders lose money.
Ideally, we want to look for trade setups with a risk / reward of at least 1 to 2.
With a risk / reward of 1:2 on every trade setup, you can lose over 50% of our trades and STILL make money.
If you execute it properly you can make consistent money over a period of time.
Win rate vs Risk reward ratio
Negative and positive Risk reward ratio is the most important metric in trading not the win rate
When used well, it can greatly improve his/her chances of becoming profitable.
Take a look at the graph below;
If you understand this connection, you can see that extremely high win rate with a bad risk reward ratio doesn’t you make money as a trader.
So, the bigger the risk reward ratio, the fewer the wins you need.
All in all, you can still make money in the Forex markets even if you lose far more trades than you win, if you keep a positive risk reward ratio.
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