The reward-to-risk ratio

In Forex markets, traders have always to pay attention to measure their trading performance. Unlike the common belief, the performance cannot be measured in absolute terms, simply as the totat return recorded over a period of time, but it has to be measured relative to a risk measure. This happens because forex trading is a risky activity and traders have a high percentage to loose their money. As a consequence, the risk measurement is as important as the measurement of return. This is why, investors have developed many indicators which encompass both variables (return/reward and risk) over the last years. The reward-to-risk ratio is a good proxy for measuring return and risk, since it measures a trade’s expected returns vis-a-vis its predetermined risk of loss.

The ratio is computed by simply dividing the profit that a trade is expected to obtain by the loss that the trade may incur.

Suppose, for example, to make $200 by buying the Cable. If a trader places his order in such a way that he stands to lose just $50, then the trade’s reward-to-risk ratio is equal to 4:1 = (200 / 50).