Risk/reward: is the trade worth taking?
Risk/reward is the ratio between what you lose if stopped out and what you gain if the target is reached; a trade whose target is closer than its stop can lose money over time even if it wins often.
In the chart above you see three horizontal dashed lines: ‘ENTRY’ is today's price, ‘STOP’ the level where the idea becomes invalid, and ‘TARGET 2R’ a target twice the distance between entry and stop above the entry. Here ‘R’ is the amount you risk on a single trade: what you lose if you are stopped out.
Risk/reward is a simple question: ‘If I am right, what do I gain; if I am wrong, what do I lose?’ If the target is 2R, each winning trade covers two losing trades. In that case you can stay profitable overall even if you are right on fewer than half your trades. If your target is closer than your stop (less than 1R), the opposite happens: you need to win very often, and a few bad streaks wipe out the gains.
Hit rate and risk/reward work together. A method that is right 70 percent of the time but whose every gain is small and every loss large can do worse than a method that is right 40 percent of the time but whose gains are twice its losses. That is why the question ‘how often do I win’ is misleading on its own.
A good trade idea makes sense where the target is realistic: if the target is on the far side of a resistance, or somewhere price is unlikely to reach in that time, a high ratio on paper means nothing in reality.
How to read it
- Before entering, write down three numbers: entry, stop, target. Divide the target distance by the stop distance; the result is the risk/reward ratio.
- Check whether there is resistance in front of the target: the real target is the first significant level price may get stuck at.
- If the ratio is below 1 (the target is closer than the stop), either do not take the trade or wait for a better entry.
- Improving the entry improves the ratio: with the same stop and target, entering lower shrinks the risk and enlarges the reward.
We measured
We measured our opportunity agent's suggestions on 217 crypto pairs. Entries whose target was closer than the stop (risk/reward below 1) made up about two thirds of the trades; 63 percent of them won, but the average result was −0.13R per trade, that is, a loss. The result stayed below zero in both halves of the measurement period. The rule ‘do not send if risk/reward is below 1’ was the only rule among those we tested that passed the stability check.
Source: BBL opportunity agent measurement: 217 crypto pairs, 15-minute bars, with a control group, 0.12% cost ·
Trap
The most common mistake is taking a high hit rate for success: a method that wins often but wins little, and loses rarely but loses a lot, looks good on paper but erodes the account. The second mistake is artificially moving the stop closer to make the ratio look good: a close stop gets hit by ordinary fluctuation, and the nice ratio on paper never materialises.
Tip
The plan note on the analysis card evaluates the risk/reward ratio together with the stop's distance in ATR. If the card shows a high ratio but a very close stop, remember the trap in this lesson.
Glossary
- R
- The amount risked on a trade; what you lose if stopped out.
- Risk/reward ratio
- The ratio of the target distance to the stop distance.
- Expected value
- The average gain or loss per trade over many trades; the combination of hit rate and ratio.
Mini quiz
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Calculate the risk/reward ratio of an analysis plan →For information only, not investment advice.