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Why do so many traders lose money in the market, despite analysing the market properly and having a high winning rate of their trades? One of the most common reasons is neglecting the reward to risk ratios of the trades.

The reward to risk ratio of a trade is simply its potential profit divided by its potential loss. Consider the following example: an investment with a reward-risk ratio of 7:1 suggests that an investor is willing to risk $1 for the prospect of earning $7.

Why is reward-risk ratio important?

Besides increasing the success rate and profitability of trades, reward-risk ratios are also important for another reason.

Let’s say you open six trades, each with an R/R ratio of 1 and identical risk-per-trade. If you manage to have three winning trades and three losing trades out of the total six trades, you’ll make a total of $0. You’ll stay on break-even.

However, if all of the six trades have reward/risk ratios of 2 (assuming identical risk-per-trades), three losing and three winning trades will now generate a handsome profit, because you’re winning two times more on each winning trade than you’re losing on each losing trade.

Using the reward/risk ratio in trading