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Risk-to-reward compares how much you stand to lose on a trade against how much you stand to gain. A 1:2 risk-to-reward ratio means you're risking $1 to potentially make $2.
This matters because win rate alone doesn't tell you if a strategy is profitable. A strategy that wins only 40% of the time can still be profitable overall if its average winning trade is meaningfully larger than its average losing trade.
In practice, this means it's worth calculating your risk-to-reward on a trade before entering it — not just whether you think it will "probably work." A trade with poor risk-to-reward can still be a bad trade even if your directional read turns out to be correct.
Real-World Example
A trader takes ten trades using a strategy with a 1:2 risk-to-reward ratio, risking $100 to potentially make $200 on each. Even winning only 4 of the 10 trades, a 40% win rate, the math works out in their favor: 4 wins times $200 equals $800, minus 6 losses times $100 equals $600, for a net profit of $200, despite losing more often than winning, because the reward-to-risk ratio did the heavy lifting rather than a high win rate.
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