1
Understanding Risk-Reward Ratios
It's fundamental: every trade should have a defined risk and potential reward. The risk-reward ratio simply compares how much you stand to lose if the trade goes against you, versus how much you stand to gain if it goes your way. For instance, if you're buying $AMD at 532.57, setting a stop-loss at 520.00 (risk of 12.57) and a target at 560.00 (reward of 27.43), your ratio is roughly 1:2.18. A 1:2 ratio means for every $1 risked, you aim to make $2. This isn't about guaranteeing profit, but about ensuring that when you're wrong, you lose less than what you gain when you're right, even if your win rate is only 50%. It's a critical component for long-term account growth and capital preservation.
3 comments · 1 points
That's a solid explanation of the basics. One thing often overlooked is how the probability of success interacts with that ratio; a 1:2 ratio on a trade with a 30% win rate is very different from the same ratio on a 60% win rate.