Anyone who has tried trading coins has faced the issue of deciding whether the deal is profitable or not. RR is the best tool to approximate your possible trading outcomes. 🙌
What is Risk/Reward Ratio
The ratio of risk and profit (Risk / Reward Ratio or RR) - a ratio of risk to potential profit. A specific RR value is calculated before buying an asset and allows you to assess the potential of the transaction in terms of the trader’s trading strategy.
In simple words
The ratio ranges between 0 and above. If the value is greater than 1, the deal is more likely to be unprofitable because the risk exceeds profit.
Profit is the difference between the purchase price of an asset and its sale price. In the context of RR ratio, profit is the potential level that a trader determines before entering a position to assess the potential of a trade operation.
RR is determined as the entrance price - stop-loss marker range over the entrance price - target price range. 🧮
Let’s say you want to buy an asset at a price of $100. You limit the risk by setting a stop loss at $90, and set a target price for yourself to sell the asset at $130. In this case, the ratio of RR is 1 to 3, or a coefficient with an approximate value of 0.33, meaning the risk is less than the potential profit. 👏
In the example with the same entry price ($100) and the same target price ($130) but with a stop loss of $40, the RR ratio would be 2. This ratio would indicate that the risk significantly exceeds the expected reward. 😬
The optimal coefficient
One of the most popular values when calculating the ratio of risk and reward is 1 to 3 or 0.33. Ratios of 1 to 7, 1 to 10, 1 to 15 are also often used. 🤔
However, there is no ratio that will make your trade 100% profitable. You could use a 1 to 2 ratio and make 100 deals with 50 being successful, but your balance would not change at all. 🤷♂️
In the example with a ratio of 1 to 3 or a ratio of 0.33, the advantage of evaluating the RR is that one profitable trade can level out 3 loss trades. In the case when the ratio is 1 to 5, one profitable transaction will be able to level out 5 unprofitable ones. 🤘
Why use RR
By using the ratio, a trader can approximate their long term outcomes and identify the amount of successful deals they need to make in order to achieve those outcomes.
Stay tuned 📻