Definition
A measure that describes the potential reward of a trade in relation to its potential risk. It’s a way to assess the risk-reward profile of a trade setup.
Formula
R/R Ratio = Profit Target / Risk
- Profit Target: The difference between your entry price and your desired exit price for a profit.
- Risk: The difference between your entry price and your stop-loss level (representing the amount you’re willing to risk on the trade).
Example
- Entry Price: $10
- Profit Target: $12 (Potential profit of $2)
- Stop-Loss: $9 (Potential risk of $1)
- R/R Ratio = $2 / $1 = 2:1
This means that for every $1 risked, the potential reward is $2.
Key Points
- Trade Evaluation: A higher R/R ratio generally indicates a more favorable risk-reward profile.
- Target Setting: R/R highlights the importance of setting realistic profit targets in relation to your risk tolerance.
