Profitable and consistent trading is about finding a balance between your win rate and risk/reward ratio. Here’s how to do it.
I have multiple strategies. Some have higher win-rates, others lower, some have high reward:risk, some have lower.
Win-rate is how many trades you win, usually given as a percentage. Such as 50%, which is 5 wins out of 10 trades, or 50 wins out of 100 trades. That means 50% of trades placed result in a profit.
Win rate is what many people focus on. They want to be right, often! Yet reward:risk (R:R) is just as important. R:R is how much a trader wins on winning trades versus how much they lose on a losing trade.
If you risk $100—that’s what you lose when you take a loss—but if you make $500 on your winners, you can have a low win-rate and still make money because your profitable trades are so much bigger than your losses.
If you lose $1,000 when you take a loss, but only make $150 when you win, it will be nearly impossible to increase the account over time because you will need to win 9 out of 10 trades to eke out a profit.
I use the reward:risk (instead of the more commonly used risk/reward) so that we can work in real numbers. 2:1, 1.5:1, 3:1 etc, or you could just say your reward is 3x your risk in the latter case. Risk/reward is another term used, and means the same thing, except then you are using a fraction. If your reward is 3x your risk, the risk/reward is 1/3, or 0.3333. I prefer using reward:risk.
Here is a quick summary of risk/reward. More details are covered in the article below.
The following video highlights some key things for maintaining a good win rate and risk/reward. As well as some problems many people run into which destroys their risk/reward and often their win rate.
Trading Win Rate and Reward-to-Risk Averages
On each trade, I determine my entry,stop loss, and profit target. This provides my estimated reward:risk for the trade.
Over many trades, I will end up with an average R:R and an average win-rate. It is these averages, over time, that matter…based onclosedtrades.
If you strive to make 20:1 R:R trades every time, but the price never hits your target, you end up with a bunch of losses and a non-existent reward. You need to be able to actually lock in those Rewards in order for it to matter.
Each trade is important—we need to execute as best we can—but we also want to think about how the strategy performs over many trades.
Interested in day trading stocks? Learn how and when to capitalize on price patterns that occur multiple times per day in stocks. Learn precise patterns to watch for that present a favorable risk/reward opportunityin thePrice Action Stock Day Trading Course.
You Can Have a High Win-Rate and Low R:R, or a High R:R and a Low Win Rate
Most people think they need to accurately predict where the market is going to make money. That is not true.
Think of trading as mathematical. Using win-rate and reward:risk you can determine what balance of those two you require to be profitable.
Profits can come regardless of how many losses you have, assuming your wins are big enough to compensate. Losses can be mentally draining if you want to be right all the time, but if your goal is to make money, losses are just a part of trading.
I think of it this way:
You can make $6K per month on a $20K account with a 33% win rate and a 5:1 reward to risk. All you need to do is place 30 trades on a $20,000 account. Based on the statistics, you are going to lose $200 of the capital on 20 of the trades you place. That means you are risking 1% of the account per trade. On the other 10 trades, your average gain is $1,000 (5:1 reward to risk). These wins and losses are randomly sprinkled over the month. Trading also doesn’t take up much time, so the job only requires a few hours per week.
20 X -$200 = -$4,000 in losses
10 X $1,000 = $10,000 in wins
Total profit= + $6,000
If want a higher income, you can always trade with more capital down the road once you have proven yourself.
When it is laid out like this, it seems pretty simple. Just trust the numbers, which are based on averages for a strategy. Every strategy will provide different statistics over the last several hundred trades.
Once we start trading, we think “If I can cut out a few of those losses, I make even more money.” Or “I don’t want to lose on a trade, so I won’t take trades I think might be losers.” Or “I just lost 4 trades in a row. I can’t handle another possible loss. I am sitting the next trade out.” Totally forgetting that we need to take those losing trades to get our monthly profit. And so we deviate. We need those 20 losses in order to find those 10 winners that give us a nice profit. You can’t have one without the other.
The example is meant to show that big returns are possible even with a low win-rate. This trader only wins 33% of their trades, yet is making a great monthly return.
Another trader could make $6k per month on a $20K account in a totally different way. They win 60% of the time and use a reward to risk of 2.5:1 on 30 trades. (This is the reward:risk I discuss in my EURUSD day trading course)
12 losses X -$200 = -$2,400
18 wins X $500 = $9,000
Profit = +$6,600
The statistics could be altered in many ways to provide different scenarios. One way isn’t better than another, but if you have a low win rate you need a higher reward:risk, and if you have a high rate you can get away with a lower reward:risk.
A high win rate and low reward to risk seems to appeal to many people, because it seems easier and less emotional to have more wins, even if they are smaller.
But make no mistake, it is not any easier. Winning 60% of trades even with a 1:1 R:R or greater is actually pretty rarified air. Most traders, even successful ones, win less than 50% of their trades.
And those people you see claiming they win 90% of their trades…they often eventually “blow up” their account because they are taking lots of tiny profits so a few big losses wipe them out.
Trying to win a lot of trades is just as hard as withstanding more losses for a few big winners that produce an overall profit. That said, a certain combination is best for YOU. Find out what you feel most comfortable with. Go by what you feel in actual trades (less stress, more confidence, etc.), not what you think you would prefer.
Risk/reward and win rate can easily be tracked by software, or by recording your trades in an Excel trade journal.
If day trading is more your thing, check out theEURUSD Day Trading coursefor ways to exploit great reward:risk opportunities multiple times each day in the forex or futures market.
The Biggest Problems People Face with Risk/Reward and Win Rate
One of the biggest problems certain traders have is holding a trade all the way to the target, whatever that target may be. The problem tends to get more pronounced the bigger the reward:risk is. Holding the trade all way to a 10:1 target may be difficult for some people (yet very exhilarating and exciting for others).
People that have a hard time holding onto profitable trades tend to jump ship before the target is reached. Once a trade is showing a profit, they are afraid of losing the small profit they have. So they close the trade with a small profit and miss out on the bigger potential. But if you hold all your losses and cut your profits early, your income evaporates. IF you cut profits and losses quickly, then you may be ok, as long as on average your wins are bigger than your losses. But then why not just start with smaller stop losses and targets to begin with?
Consider what kind of trader you are. Would you rather have big winning trades where you just sit back and watch them unfold? Or would you rather collect smaller gains more often? One is not better than another, but going against your nature is wrong and will result in frustration and likely failure. Know yourself, and then create a strategy around it.
Another thing to consider is that you need to have losing trades to capture the profitable trades. Profitable trades are typically worth more than a losing trade (assuming a higher than 1:1 reward:risk), so if you start trying to “skip” losing trades, and you skip a winner by accident, that is REALLY going to hurt. You just gave up $2,000 trying to avoid a $400 loss (5:1), or gave up $800 to avoid a $400 loss (2:1)!
Trying to avoid losses is likely the biggest problem for many traders. Losses mess with our heads and our capital, so there is a strong incentive to avoid them. Let me try to reframe that problem for you with an analogy:
I hire you to implement MY strategy for me. I give you all the rules and all you have to do is follow. You are not trading. You are just following my instructions/strategy, similar to putting together Ikea furniture. If you follow the rules I will give you a $10,000 salary per month.
$10,000 is the maximum I will pay you for implementing my strategy, because that is how much the strategy makes in a month based on the capital I have allocated to you.
But, for each mistake you make I will deduct $1,000 from your pay. If you make 10 mistakes in a month—taking a trade that wasn’t part of the strategy, getting out early, getting in early, not taking a valid trade, wrong position size, not setting a stop loss, holding a loss or profit longer than strategized, etc.—your income is down to $0.
Would you take this job, placing 30 trades a month? That’s all you have to do is execute 30 trades correctly and make $10K? You could probably do it in your spare time! Do you think that would be easier than trading on your own?
That IS trading! That IS your job as a trader! But your boss isn’t me, it is YOU and your strategy, and it’s the market that deducts your pay for mistakes. Reducing mistakes (your actions versus the strategy) is the easiest way to start making serious money. Yet, few monitor their mistakes or try to improve on them. Instead, they try another strategy and make the same mistakes.
Your strategy and capital define your salary. It is your profit potential. Don’t try to make more than your salary dictates by deviating from your strategy. If you want a bigger salary, create better or more strategies. Or trade with more capital once you have proven you can be profitable.
This scenario is your life as a trader, but hopefully, it makes you think about trading in a different light and will help you stick to your strategy better.
Follow your trading rules and strategies. Capture the salary that is owed to you, and don’t dwindle it away on mistakes.
Strategy Determines the Average Win-Rate and Reward:Risk
Your strategy determines what your win rate and R:R will be. But you get to create your strategy based on your preferences and your goals.
Once you understandposition size, you can create massive reward:risk ratios based on relatively small price moves.
You don’t need to use the same reward:risk on every trade. You can let the market determine it (I will explain shortly), but only take trades when the reward:risk is favorable (above 1:1). On a side note, this is why you should never trade binary options. Winning 70% of your wagered capital on a trade seems alluring, but people forget they are risking 100% of the amount they bet. You win less than you lose (0.7:1), the opposite of what you want. Even a winning hand in blackjack has a payout of 1:1!
As a swing trader, for example, you may see the price approaching the top of an expanding range on the daily chart. You decide to drop down to an hourly chart, and then a 15-minute chart, watching forsigns that that price is starting to reverselower.
You enter short and place a stop loss 50 pips above the entry, just above the recent swing high. You place a target 375 pips away, near the bottom of the expanding range.
This is a nearly 8:1 reward-to-risk trade. Or 8R for short. The target is not outlandish, it is based on movements the price has made recently.
The example below, based on a forex swing trading strategy called Price Structures, provided two chances for entry. The trade provided a big boost to the account and lasted 4 days.
Charts from.
A day trader could find a similar setup that lasts a few minutes to an hour or so. They may find a nice small consolidation near a support or resistance level that allows them to use a 4 pips stop loss, yet based on the recent price action they can reasonably expect a 30 pip move over the next few price waves. That’s a 7.5R trade.
Or a day trader could routinely take 1.5:1 or 2:1 reward:risk trades, locking in smaller gains throughout the day, like discussed in the Day Trading Stocks with a Trend Following Strategy.
Here’s an example on the EURUSD 1 minute chart.
A swing trader could do something similar, or go for bigger R:R ratios.
Here is an example of a swing trade based on a contraction pattern. The stop loss was placed 3% away from the entry and the target was 12% away. That’s 4:1.
Here is another example of using risk reward while day trading stocks. I will often watch several stocks from the Best Day Trading Stocks list near the market open. I am looking for specific patterns and when I see them I deploy a market order with a target and stop loss attached. The target is twice the size as the stop loss (2:1).
But How Do You Know?
The question that always comes up is “But how do I know the price will run X amount to hit my 10:1 target, my 2:1 target, my 5:1 target, etc.?”
You don’t! And you never will. That’s why you just need to place targets based on rational levels, that are based on a tested and verified strategy. That way you’ll have confidence in the trades you take, even if some (or lots) of them don’t work out. Sometimes the price runs to them, and other times it doesn’t. Remember, you only need a few wins to overcome a lot of losses when you use a high reward:risk. And the smaller your reward:risk typically the easier it will be to get a higher win rate.
If you are struggling to find “reasonable” targets, look at recent price action. I discuss this in the Price Action Day Trading Cheat Sheet (although many of the concepts apply to swing trading as well).
Your strategy testing and practicing should tell you what you can expect in terms of win rate and risk/reward. If you don’t like the results, change the strategy.
Let math do the work. If you structured your strategy well and have verified that it works, let it play out. Collect your salary without deductions!
Trailing Stop Losses
Profit targets are not required.Trailing stop lossescan also be used. Your strategy testing will still reveal your win rate and average reward:risk over many trades.
Trailing stop losses can be very effective at times. For instance,Renko charts, which can be used as a trailing stop loss, are effective in strong trending periods. In day-to-day conditions when price action is choppier, profit targets are the better choice as the trailing stop will likely close the trade at inopportune times.
Profit Problems Fixed
If you track your win-rate and R:R you can typically find your problem. Go through your trades, see if you can make a bit more on them. Maybe you are taking profit too early.Or maybe your profit targets, on average, are just a tiny bit too far out, so they aren’t being reached and the price reverses. Decrease your reward:risk slightly. Or better yet, see if you can reduce your risk. Then you can keep your reward:risk about the same, but your target is closer to the entry point.
Maybe your entries are poor (learn to improve your entries) so the price is reversing after you enter and not giving you the chance to capture those big gains.Where is the profit potential in relation to your entry? Was it before, did it come after? Fine-tune your entry based on what you discover.
When you track and look at these statistics, they will tell you what you need to do to improve.
Final Word on Win-Rate and Reward-to-Risk
I like getting the odd high R trade, but also grabbing consistent 2.5:1+ (forex day trading) and 3:1+ (stock swing trading) trades. If you can snag the odd, 10R or 20R trade, that covers a huge amount of losses. You don’t always need to go for those types of trades…trade the reward:risk the market is providing. Sometimes that is 5:1, or 3:1 or 8:1. Sometimes it is 30:1.
Think about if you added one or two 20R or 30R trades per year. If you risk 1% of your capital per trade, that one trade increases your account by 20% or 30%. That’s a huge addition to the bottom line. But these opportunities may not come along very often. You also need to be in the right mind frame to hold that winner, possibly through some ups and downs before it reaches the target, so multiple factors must align for the opportunity to occur and for you to actually capitalize on it.
The other option is nailing quick profits regularly, seeking a higher win-rate but typically having a lower reward:risk. I do this most of the time, taking 2:1 and 3:1 trades, but I am aware of certain market conditions where I may be able to get a much larger profit. In those cases, I remain open to expanding my profit target or using a trailing stop loss to potentially grab a really big profit. In your trading plan, specify under what conditions you will try for small R:R or bigger R:R.
Your profit zone is somewhere out there, a balance between your win-rate and reward-to-risk. You may not need to change your whole strategy if you are struggling. A couple of small tweaks could turn a loss into a win, or increase the average profit of your trades.
FAQS
What is win rate in trading?
Win rate is how many trades you win, as a percentage, out of the total number of trades placed. Winning 5 out of 10 trades is a 50% win rate. Winning 30 out of 100 is a 30% win rate. Most professional traders have a win rate near 50% or less. They are profitable because they make more on winning trades than they lose on losing trades.
What is risk reward in trading?
Risk/reward is a ratio of the size of winning trades compared to losing trades. If lose $100 on a losing trade but make $200 on a winning trade your risk/reward is 100/200=0.5. You can also think of it as reward/risk = 200/100 = 2. Meaning your win is twice as big as your loss. Take an average over many trades to see your average risk/reward. Most professional traders make more on their winners than they lose on their losses. That way, they can win 50% or less of their trades and still be profitable.
By Cory Mitchell, CMT
If you are interested in swing trading, see my Complete Stock Swing Trading Course for methods on finding stocks with fantastic reward:risk ratios.
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.
