Using the Risk/Reward Ratio…

Risk/Reward Ratio is very widely used by professional traders to keep odds in their favor to improve profitability. In this blog post, we would like to explain what it means and how it can be used in your trades to improve the chances of turning a profit.

In order to calculate the Risk/Reward ratio though, we need to first define what is Risk and Reward.

• Reward is the maximum profit you can have.
• Risk is the maximum loss you can have.
• Risk/Reward ratio is simply your Reward divided by Risk. e.g. a 3:1 Risk/Reward ratio means that your Reward is 3 times the Risk.
• A High Risk/Reward minimizes your risk and maximizes your profit.

Since most professional traders put stop-losses to protect their investments, Risk can be defined as the maximum loss that you can tolerate and hence it is nothing but the stop-loss. Usually the Stop-Loss depends on your type of trading because your expectation of gain is different based on whether you are a long-term trader, short-term trader or an intraday trader. Since typically anything above 3:1 is considered a very good Risk/Reward ratio, generally the Stop-Loss is also chosen to keep the Risk/Reward ratio > 3.

Here are the stop-losses based on different trader types:

Trader Type	Ideal Gain	Typical Stop-Loss
Long-Term	> 50%	10%
Short-Term	15-25%	5%
Intraday	2-3%	0.5%

Since Reward is defined as the maximum profit you can have and one way to measure it would be based on what target you expect to achieve. This target is usually the nearest support or resistance and depends on whether you are buying or short-selling:

• For long trades (buy), profit = target – purchase price. If you want to estimate the reward at the current closing price, then this is = nearest resistance – close
• For short trades (i.e. when you short sell), profit= short-sell price – target. If you want to estimate the reward at the current closing price, then this is = close – nearest support

Usually, one draws the support/resistance manually and then calculates the reward based on that. But, with the soon to be announced Auto-SR addon, Investar will have the capability of not only drawing the support/resistance automatically using Artificial Intelligence, but also to calculate the Risk/Reward ratio based on that.

To configure the Risk/Reward ratio, you need to set the stop-losses based on the type of trading you do:

Then, when you visit any chart, the Risk/Reward ratio and the Stop-Loss are automatically displayed on the chart. e.g., if you visit an intraday chart (<15min based on above options), it is displayed as follows:

And for a short-term chart, it displayed as follows:

For more details, check out our video on “Using Risk Reward Ratio to Maximize Profits in Trading” ” for an in-depth look into this topic :