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Risk reward ratio: what is it & why is it important?

The risk reward ratio (RRR), known in German as the chance-risk ratio (CRV), is a central concept in trading that helps assess opportunities and risks in a structured way. It shows the relationship between potential gain and possible loss of a trade, supporting traders in making informed decisions. A well-calculated chance-risk ratio can increase long-term success by setting clear criteria for entries and exits. But how can the risk reward ratio be calculated? And what strategies help make the most of this ratio? This guide provides a clear explanation and shows how traders can effectively integrate the chance-risk ratio into their strategy.

The risk reward ratio (RRR), or chance-risk ratio, helps traders evaluate the relationship between potential gain and possible loss to make informed decisions.
A good chance-risk ratio (e.g. 1:3) can lead to stable returns over time, even if not every trade is successful.
Risk management is essential: with stop-loss orders, position size adjustments and volatility analysis, losses can be limited.
Disciplined traders set clear RRR thresholds and avoid trades that don’t match their planned CRV to minimise impulsive decisions.

What is the risk reward ratio and why is it important for traders?

The risk reward ratio (RRR) describes the relationship between a trade's potential gain and its possible loss. It shows how much a trader can earn in the event of success, compared with the share of risk taken. For example, a chance-risk ratio of 1:3 means the potential reward is three times greater than the risk involved. This ratio helps assess individual trades objectively and develop strategies aimed at long-term profitability.

A well-calculated risk reward ratio supports traders in making informed decisions and increasing the value of their profitability. It helps assess risk more accurately and define clear entry and exit points. Without a structured chance-risk ratio, there's a greater risk of impulsive decisions and unnecessary losses. By applying the RRR regularly, traders can protect their capital more effectively and trade more successfully in the long run.

What role do risk and return play in trading?

In trading, risk and return are directly linked. Every trade carries the potential for profit, but also the chance of a loss. The risk reward ratio (RRR) helps traders structure these two factors and make well-informed decisions. While high risk often comes with the promise of higher returns, excessive risk-taking can also result in significant losses. To be successful over time, it's essential to use the chance-risk ratio strategically and aim for a balanced relationship between risk and reward. The next sections explain how risk and return behave in the market in more detail.

Market risk

Risk is a key factor in trading and influences every decision. It refers to the potential loss a trader is exposed to in a trade. Market conditions are often volatile, meaning prices can fluctuate rapidly. In the forex, stock and crypto markets in particular, volatility and leverage vary greatly and can intensify the actual value of risk at critical points. The risk reward ratio helps assess these factors and develop a sound strategy.

A practical example: in the crypto market, sharp price swings are common, so traders may need to aim for a higher chance-risk ratio than in the less volatile forex market. While an RRR strategy of 1:3 might make sense for traditional stocks, a modified ratio may be required in volatile crypto trading. With targeted risk management like stop-loss orders and position sizing, traders can manage risks more effectively and reduce losses.

Market return

Return is the core goal of any trade and represents the potential profit in relation to the risk taken. High returns are appealing, but they often involve higher risks. The RRR helps traders find a balance between the two factors to build a profitable long-term strategy.

In highly volatile markets like crypto trading, strong price movements can lead to large short-term profits. By contrast, forex and stock markets typically offer more stable returns with lower risk. The key is to optimise the chance-risk ratio to reflect realistic profit targets, maximise return value and reduce losses at critical points. This approach supports long-term success. A disciplined method that applies the RRR consistently can lead to higher profitability over time.

What is the chance-risk ratio (CRV)?

The chance-risk ratio (CRV) is an important indicator in trading that shows whether a trade makes sense from the perspective of risk and potential return. It describes the relationship between potential profit and the maximum loss a trader is willing to take. For instance, a CRV of 1:3 means the potential profit is three times greater than the risk.

The CRV is not just a metric but a method for tailoring trading strategies to personal risk tolerance. A conservative trader might prefer a lower risk reward ratio (RRR), while a risk-tolerant trader may accept higher risks if the potential return is high enough. What matters is that the chance-risk ratio is consistently included in trading decisions to achieve sustainable long-term profitability.

How is the risk reward ratio calculated?

The risk reward ratio is calculated by dividing the potential profit by the possible risk. The formula is:

Risk reward ratio (RRR) = Potential profit / Potential loss

The result shows the relationship between risk and reward, helping traders estimate the potential gain as a percentage of total risk and make informed decisions. A higher RRR means the potential profit is greater in relation to the risk. With this strategic approach, traders can better adjust their strategies and optimise profitability.

Practical example of the chance-risk ratio

A trader plans a trade and sets clear entry and exit parameters to follow a consistent strategy. They decide to risk €50 with a profit target of €150.

Now the RRR is calculated:
Risk: if the price moves negatively, the potential loss is €50
Reward: if the target is met, the potential profit is €150

The calculation:

RRR = 150 / 50 = 3 → Chance-risk ratio of 1:3

This chance-risk ratio shows the potential gain is three times higher than the possible loss. By setting a fixed stop-loss and clear profit target in advance, the trader improves their risk management, better controls risk and defines objective decision points. Applying this method consistently helps achieve stable long-term returns and avoid impulsive mistakes.

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How is risk measured?

Accurate risk management is crucial for successful trading. To apply the risk reward ratio effectively, traders must quantify potential losses and develop strategies to limit risk. Several methods allow for objective risk assessment. By using these tools, traders can calculate their chance-risk ratio and align strategies to ensure losses remain manageable at key points. Strategic risk measurement leads to better decisions and long-term trading success.

Key approaches include:

Stop-loss orders: set automatic exit points to limit losses
Volatility analysis: assess market fluctuations to evaluate the chance-risk ratio realistically
Historical price data: use past price movements to estimate future risks more accurately
Position sizing: adjust capital deployed according to individual risk reward ratios

How can traders manage risk?

Thoughtful risk management is essential for long-term profitability. Even with a solid risk reward ratio (RRR), losses can't be avoided entirely, but they can be controlled. Traders should apply targeted strategies to reduce risk and boost returns.

Key risk-reduction measures:

Set firm stop-loss orders: automatically limit potential losses at predefined levels to make the most of the chance-risk ratio
Adjust position sizes: avoid risking too much per trade by calculating and adapting the RRR
Use diversification: avoid putting all capital into a single asset by trading across markets or asset classes
Analyse volatility: in highly volatile markets (e.g. crypto trading), use adapted RRR strategies
Control emotions: stick to a fixed trading plan and avoid impulsive decisions
Review past trades: analyse both wins and losses to improve your chance-risk ratio over time

What to watch out for with the risk reward ratio

To achieve long-term success, traders should ensure the RRR is at least 1:1. This means the potential gain should be equal to or greater than the possible loss. Otherwise, even a high win rate might not be enough to maintain stable returns. A trader with a 1:1 RRR and 50 percent win rate would break even over time, as the gains only just offset the losses. A greater chance-risk ratio (e.g. 1:2 or 1:3) creates an advantage, even if not every trade is successful.

It's also important that the risk reward ratio is realistic and aligns with the trader’s strategy. An overly high RRR may lead to rarely achieved profit targets, while a low ratio increases the risk of long-term losses. Traders should calculate, tailor and consistently apply their risk reward ratio to ensure sustainable profitability.

Types of trading and investment risks

Each trade carries different risks that can affect profitability and the risk reward ratio (RRR). For long-term success, traders should understand these risks and apply appropriate strategies to manage them.

Key risk types and ways to reduce them:

Market risk:

Cause: fluctuations in asset value due to supply, demand or unexpected events
Strategy: set stop-loss orders, adapt risk management to market conditions

Liquidity risk:

Cause: an asset can’t be bought or sold quickly at the desired price
Strategy: favour highly liquid markets, avoid wide spreads that increase trading costs

Leverage risk:

Cause: leverage magnifies both gains and losses
Strategy: use leverage cautiously, adjust position sizes, don’t risk full capital on one leveraged trade

Volatility risk:

Cause: sharp fluctuations, especially in markets like crypto trading, can impact the risk reward ratio
Strategy: use volatility analysis to set realistic RRR targets

Psychological risk:

Cause: emotional decisions like fear or greed affect trading strategy
Strategy: define clear rules, stay disciplined, keep a trading journal

Regulatory risk:

Cause: legal changes may affect certain assets or markets
Strategy: stay informed on regulations, diversify investments

Conclusion: how traders can use the risk reward ratio effectively

The risk reward ratio (RRR) is a key tool for disciplined trading, helping traders make informed decisions. Those who focus on trades with a favourable chance-risk ratio can achieve stable long-term returns and reduce unnecessary losses by maintaining a high percentage of successful trades. The key is to set realistic RRR thresholds that support a healthy balance between risk and reward.

Traders should only enter trades that align with their planned CRV to preserve strategy value and avoid impulsive decisions at sensitive points. At the same time, risks must be managed with tools like stop-loss orders, position sizing and volatility analysis. Regularly reviewing past trades also helps refine the personal risk reward ratio.

By applying these principles, traders can not only calculate the chance-risk ratio but also use it deliberately to build a sustainable, more successful trading strategy. Those who manage risk and reward strategically can trade with greater confidence and succeed over the long term.