Reward-To-Risk Ratio (RRR)

The Reward-to-Risk Ratio (RRR) is a key concept in trading and investing that helps traders evaluate the potential reward of a trade relative to the potential risk they are taking.

It is a simple way to measure how much traders stand to gain versus how much they are willing to lose on a particular trade.

Here’s how to measure the RRR in a simple 4-step process:

1. Evaluate potential price levels for stop loss and profit target: look at the chart and determine where to place the stop-loss (SL) and profit target (PT). The SL is the price level at which we exit the trade if it moves against us, and PT is the price level at which we exit the trade if it moves in our favour;
2. Measure the distance between entry and stop loss: calculate the distance between entry point and stop loss. This is the “Potential Risk” we are willing to take on the trade. For example, if we enter a trade at 1.2000 and set stop-loss at 1.1950, the distance between entry and stop-loss is 50 pips;
3. Measure the distance between entry and profit target: calculate the distance between entry point and profit target. This is the “Potential Reward” from the trade. For example, if we set a profit target at 1.2100, and the entry point was 1.2000, the distance between the two is 100 pips;
4. Divide potential reward by potential risk: to find the RRR, simply divide the potential reward by the potential risk.

Let’s say we plan to buy GBP/USD, and expect to make a potential profit of $150 on this trade.

If we set a stop loss so that the maximum loss we would incur is $50, the trade’s reward-to-risk ratio would be calculated as:

RRR = Potential Profit / Potential Loss

150 / 50 = 3 : 1

This means that for every $1 we risk on the trade, we are aiming to make $3 in profit. This is considered a good reward-to-risk ratio, as it allows to stay profitable even if we are not winning every single trade.