The Investor Diary Entry #72: February 1, 2025
Risk management is the backbone of any successful Forex trading strategy. If we don’t manage our risk properly, it doesn’t matter how good our technical analysis is—we are setting ourselves up for failure. One of the most important risk management tools every trader must understand is the Risk-to-Reward Ratio (RRR).
So, in this article, I’ll break down my understanding of what is the Risk Reward Ratio formula, why it matters, and how I use it to protect my capital and grow my account strategically. If one is serious about how to learn risk management in Forex trading, this is one concept, cannot be ignored.
What is the Risk Reward Ratio in Forex Trading?
The Risk Reward Ratio is a simple but powerful concept that helps traders assess whether a trade is worth taking based on the potential profit compared to the potential loss.
For example, if you risk 50 pips to make 100 pips, your risk-to-reward ratio is 1:2 because for every 1 pip risked, you expect to gain 2 pips. If you risk 50 pips to gain 150 pips, the ratio is 1:3.
If you take 10 trades with a 1:2 RRR and win only 4 of them, you will still be profitable.
- Losing 6 trades: 6 x -50 pips = -300 pips
- Winning 4 trades: 4 x 100 pips = 400 pips
- Net profit = 400 – 300 = 100 pips
The general rule of thumb is that a higher reward compared to the risk taken is better, but that doesn’t mean blindly chasing high RRR trades. The key is to maintain consistent risk management while ensuring that your strategy provides a good win rate.
I made several mistakes with just measuring the distance between Stop-Loss and Take-Profit prices to ensure a minimum of 1:2 RRR. With that method, I ignored all the obstacles that the price would face on its way toward the Take-Profit target price.
Why is the Risk Reward Ratio Important in Forex Trading?
Many traders focus too much on winning trades and not enough on how much they are actually risking. That’s where the RRR comes into play. Here’s why it matters:
1. Protects Our Capital
Forex trading is not about winning every trade; it’s about surviving the losing streaks. If we keep our risk controlled and ensure that the potential reward is higher than the risk, we can survive bad trades and still grow our account over time.
2. Helps Us Stay Profitable Even with a Low Win Rate
Let’s say we have a risk-reward ratio of 1:3. Even if we only win 40% of our trades, we will still be profitable because our winning trades make up for the losses.
- Losing 6 trades: 6 x -50 pips = -300 pips
- Winning 4 trades: 4 x 150 pips = 600 pips
- Net profit = 600 – 300 = 300 pips
3. Eliminates Emotional Trading
Sticking to a defined RRR prevents you from making impulsive decisions. When you know your maximum risk before entering a trade, you trade with logic, not emotions.
This is very important and we have dedicated a whole diary entry about The Psychology of Risk.
The Risk Reward Ratio Formula
Calculating the risk-reward ratio is straightforward. Here’s the formula:
Risk Reward Ratio = Potential Profit / Potential Loss
For example:
- If you set a stop-loss 50 pips below your entry and a take-profit 100 pips above, your risk-reward ratio is:
100 / 50 = 2 (or 1:2 RRR) - If you risk 30 pips to gain 90 pips, your RRR is:
90 / 30 = 3 (or 1:3 RRR)
As a rule, many professional traders aim for at least 1:2 or higher.
How to Apply the Risk Reward Ratio in Our Trading Strategy
Understanding the RRR is one thing, but actually using it in our strategy is where it gets interesting. Here’s how you can apply it effectively:
1. Always Define Your Stop Loss and Take Profit Before Entering a Trade
Before clicking that buy or sell button, calculate how much you’re willing to risk per trade and where your logical profit target is.
2. Ensure Your Strategy Supports a Good RRR
A trade setup with a 1:1 risk-reward ratio is not ideal unless you have a very high win rate (above 70%). Instead, aim for trades with at least a 1:2 RRR to make sure your winners cover your losses. Well, at least this is what I do, and how my risk management plan is set.
3. Don’t Just Chase High RRR Trades—Consider Win Rate Too
Many traders fall into the trap of looking for 1:5 or even 1:10 trades without considering their probability of success. A lower RRR with a high win rate is sometimes more reliable.
This is what I was referring to at the beginning of the article when I said I used to apply RRR blindly without noticing other signs on the chart.
4. Adjust Your Position Sizing to Keep Risk Consistent
If you normally risk 2% per trade, don’t increase risk just because a trade has a higher RRR. Stick to your money management rules.
Position sizing will be our next article, and the one that I think completes the risk management triangle; risk per trade, RRR, and Position sizing.
Common Mistakes Traders Make with the Risk Reward Ratio
Even after understanding RRR, traders including myself still make avoidable mistakes. Here are some we need to watch out for:
1. Ignoring Market Conditions
The risk-reward ratio alone won’t make you profitable. You must combine it with proper technical and fundamental analysis.
If I am going to explain this to myself I would say if a trade does not show a possibility of winning double its risk, then I would not take it, and I will not force it even if I was 100% sure of its direction. It is just not worth my money.
Consider every trade as an investment. To me it is not worth it to put one dollar at risk to generate one dollar. If it didn’t have the chance to generate 2 dollars or more for me, and the market is supporting that, then the trade is not worth it for me, and I move on to find a better opportunity.
2. Forcing Trades to Fit an Ideal RRR
Don’t adjust your take profit or stop loss just to match a 1:3 ratio if it doesn’t align with market structure. The key is finding the balance between risk and realistic price targets.
3. Risking Too Much on a Single Trade
Even with a high RRR, over-leveraging can wipe out your account. Always maintain proper risk per trade. This goes into the heart of our previous article which talks about deciding how much to risk per trade.
Does a Higher RRR Always Mean a Better Trade?
Not necessarily. A trade with a 1:10 RRR sounds great, but if the probability of hitting your take profit is only 10%, then it’s not a good trade. That’s why balance is key.
A well-structured trade with a 1:2 or 1:3 RRR and at least a 40-50% win rate is often more sustainable than trying to hit high RRR trades that rarely materialize.
Final Thoughts: Mastering Risk Management with the Risk Reward Ratio
If one truly wants to learn risk management in Forex trading, the Risk Reward Ratio should be a core part of the strategy. It helps control losses, stay profitable over time, and trade with confidence.
To summarize:
- Always define our risk and reward before entering a trade
- Aim for at least a 1:2 RRR, but balance it with our win rate
- Avoid forcing trades just to fit a specific RRR
- Stick to consistent risk management rules
Mastering the RRR won’t happen overnight, but by applying it consistently, I noticed a significant improvement in my trading performance.
Let me know in the comments—what is your ideal RRR, and how do you apply it in your trading?
If you want to follow the series here is the sequence.
How To Learn Risk Management in Forex Trading
Risk Reward Ratio Formula (This Article)
We are still adding to the series
The Investor
Saturday 1 February 2025
About The Author
I started to look into individual stocks in January 2022. I created this diary initially for myself to track my investing progress, and second, as a place where I can share my ideas publicly hoping that others will share their ideas and learn from each other, and lastly as an online business where some links that I share are affiliate links, and if anybody bought anything by clicking those links, I will get a commission based on that successful sale, which of course will not affect the price that you are buying the product or service at.
For more detailed information on my affiliate disclosure please refer to the Full Affiliate Disclosure page.
Furthermore, this site is in no way or form giving any financial or investing advice, nor it is encouraging or discouraging people to buy or sell any financial instrument. This is a personal diary in which I track my own progress and share it for informational, educational, and entertainment purposes.
The Investor’s deep dive into the Risk Reward Ratio (RRR) is a must-read for any Forex trader looking to master risk management. The emphasis on balancing risk and reward with a proper win rate is crucial, as blindly chasing high RRR trades can be misleading. One key takeaway is that survival in Forex is not about winning every trade but managing losses effectively. The real game-changer is understanding that even a 40% win rate can be profitable with a strong RRR strategy.
A particularly valuable insight is the reminder that market conditions should dictate trade decisions, not just an arbitrary RRR. Traders often fall into the trap of forcing trades to fit a ratio rather than aligning them with realistic price movements. The discussion on avoiding emotional trading through predefined risk management is also spot-on—trading should always be strategic, not impulsive.
This article is an excellent resource for those serious about Forex risk management. The next topic on position sizing will undoubtedly add another layer to building a sustainable trading strategy. Looking forward to it!
The core of Risk management is based on three main number; Risk as a percentage of capital, RRR, and Position sizing.
If that was preceded by a list of financial goals, then the trader has a plan for the long run.