Every trader wants a systematic edge in the market, some way to make money simply by using certain parameters of a trade. One such parameter is the risk to reward ratio, the potential maximum gains divided by the potential maximum loss. There are those that believe that it should always be greater than one, in other words your wins are worth more than your losses. That way even if you lose more times than you win you still come out ahead since your wins are worth more. There is, however something overlooked in this logic: the effect that the risk to reward ratio has on your win percentage.

Intuitively, we know that the current price is more likely to change to a closer price than a further one, but it can be seen empirically as well. It can be seen, that the number of bullish candles is statistically equal to the number of bearish candles, on any time frame, and that the bullish or bearish outcome of a candle is independent of the previous candle. So we can assume that at any given time the market has an equal chance of going up or down. Therefore a stop loss and take profit that are equal distances apart from the current price are equally likely to be hit. However, if one of them, say the take profit, is further away then it is less likely to be reached by a factor of the quotient of the two. For example, a take profit that is twice as far away as the stop loss is half as likely to be reached. This being the case, the expected outcome of any trade with any risk to reward ratio is always the same: zero (actually it is slightly negative when spread is factored in).

Intuitively, we also know that the market is not completely random, it may seem random at times and displays many of the traits of randomness, but this is because events are transpiring that we cannot see. Through time and experience though a trader can train himself to pick up on what the market is saying, and see though the randomness to what is actually happening in the market. This trader is no longer guessing he is interpreting what the market is saying and is no longer bound to the probabilities. Without any experience, a trader is guessing and at that point is trading in a random market, from his perspective.

On its own, no risk to reward ratio is better than any other. It cannot increase your winnings. There is no right or wrong one. It is simply one piece of this whole successful trading puzzle. As long as the trader is no longer guessing, a solid risk to reward ratio can help hold on to winnings, and help ensure long term success. The correct risk to reward ratio is dependent on the trader and his own trading psychology. Look back on your own trades and find which ones were better trades. Did you fare better by letting your trades run or by cutting them short? This is why keeping a trade journal is so important. Learning from your past trades is key to trading well in the future.