Course Content
What Is the Risk/Reward Ratio and How to Use It
Should I risk my time to get rewarded with the information in this article? The risk/reward ratio tells you how much risk you are taking for how much potential reward. Good traders and investors choose their bets very carefully. They look for the highest potential upside with the lowest potential downside. If an investment can bring the same yield as another, but with less risk, it may be a better bet. Interested to learn how to calculate this for yourself? Let’s read on. Contents Introduction What is the risk/reward ratio? How to calculate the risk/reward ratio The reward/risk ratio Risk vs. reward explained Closing thoughts
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What Is the Risk/Reward Ratio and How to Use It
About Lesson
Let’s say you want to enter a long position on Bitcoin. You do your analysis and determine that your take profit order will be 15% from your entry price. At the same time, you also pose the following question. Where is your trade idea invalidated? That’s where you should set your stop-loss order. In this case, you decide that your invalidation point is 5% from your entry point.

It’s worth noting that these generally shouldn’t be based on arbitrary percentage numbers. You should determine the profit target and stop-loss based on your analysis of the markets. Technical analysis indicators can be very helpful.

So, our profit target is 15% and our potential loss is 5%. How much is our risk/reward ratio? It is 5/15 = 1:3 = 0.33. Simple enough. This means that for each unit of risk, we’re potentially winning three times the reward. In other words, for each dollar of risk we’re taking, we’re liable to gain three. So if we have a position worth $100, we risk losing $5 for a potential $15 profit.

We could move our stop loss closer to our entry to decrease the ratio. However, as we’ve said, entry and exit points shouldn’t be calculated based on arbitrary numbers. They should be calculated based on our analysis. If the trade setup has a high risk/reward ratio, it’s probably not worth it to try and “game” the numbers. It might be better to move on and look for a different setup with a good risk/reward ratio.

Note that positions with different sizing can have the same risk/reward ratio. For example, if we have a position worth $10,000, we risk losing $500 for a potential $1,500 profit (the ratio is still 1:3). The ratio changes only if we change the relative position of our target and stop-loss.

The reward/risk ratio

It’s worth noting that many traders do this calculation in reverse, calculating the reward/risk ratio instead. Why? Well, it’s just a matter of preference. Some find this easier to understand. The calculation is just the opposite of the risk/reward ratio formula. As such, our reward/risk ratio in the example above would be 15/5 = 3. As you’d expect, a high reward/risk ratio is better than a low reward/risk ratio.

Example trade setup with a reward/risk ratio of 3.28.

Exercise Files
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