For some reason, most resources talk about a Risk To Reward Ratio, as opposed to the more meaningful Reward To Risk Ratio.

One of the main tenants of trading safely — particularly in the dynamic FOREX foreign currency market — is to risk less than what your target profit goal is, ex. only risk 10 pips with a profit target of 20 pips.

So, which would be the better, or simpler, way of expressing this?

However, if you express this situation as a Reward To Risk Ratio then the equation becomes: 20 pips / 10 pips = 2, i.e. your reward is twice your risk — a much simpler expression of the situation.

Most resources talk about using a Risk To Reward Ratio, but produce results using the Reward To Risk Ratio format. To me, this not only does not demonstrate a full understanding of how to look at a situation, but it's also poor educational practice.

Now, regardless of which form of the ratio you're talking about, it's used in many different problem spaces, not just trading. Calling it, and expressing it, as Risk To Reward may be appropriate in some contexts, but not in trading.

In trading, the proper form of expressing and calculating this ratio is via Reward To Risk.

Now, I didn't write this post just to say that I don't use the Risk To Reward Ratio form, but rather "invert" that to Reward To Risk Ratio form. The discussion so far has simply been to clearly identify how this ratio should not only be stated, but how it should be calculated for trading purposes.

So, what then do I mean by the post topic: Why I Trade FOREX With An Inverted Reward To Risk Ratio?

The motivation for this is that if you have a 33% win rate (win 1 trade; lose 2 trades) with a Reward To Risk Ratio of 2:1, i.e. 20 pip profit target vs 10 pip stop, that you won't go broke.

Well, there are a lot more factors involved in not going broke than simply having a 2:1 Reward To Risk Ratio, but from a strictly mathematical standpoint under the conditions of 1 win in 3 trades, you won't go broke.

And that is sort of intuitively understood, anyway, right? I mean, you would never want to invert the trade with taking more risk than the potential reward.

Or would you....

That's the inversion situation I'm talking about that I take in my trading.

What? I must be an idiot then, right?

Stay with me here....

What I'm suggesting here is using a Reward To Risk Ratio of 1:2, 1:3, or even 1:4. That would imply, for example, having a 10 pip reward, but taking a 40 pip risk (1:4).

So, applying this ratio to the 1 win for every 2 losses example above (i.e. the 33% win rate) a 1:4 Reward To Risk Ratio would mean I win 10 pips once for every 2 times I lose 40 pips; a net loss then of 70 pips. That's just crazy, yeah?

Well, yes it would be under only a 33% win rate, i.e. I win 1 time and lose 2 times, so 1 win out of 3 trades is a 33% win rate. Even if my win rate was 50%, a 1:4 Reward To Risk Ratio causes a net loss of 30 pips (i.e. 1 win for 10 pips, and 1 loss of 40 pips).

But I don't have a 33% win rate; mine is more around 70% because of the short in and out trading I do as a speculator. But even then, using the 1:4 ratio means that out of 10 trades I win 7 at 10 pips for 70 pips and lose 3 trades at 40 pips for 120 pip total loss for a net loss of 50 pips.

So then: I must still be an idiot, or something, right?

Well, not quite....

Someone looking at my set up analysis would think that my risk was 40 pips with a profit target of only 10. But they would be incorrect in assuming that.

Just because the apparent 'best practices' analysis of my setup indicated a 40 pip risk, that risk is only 'potential'. It only becomes a realized loss if I allow the trade to go 40 pips against me.

But, I have no intention of letting price go 40 pips against me.

Why is that?

And that apparent 10 pip profit target is really 20 pips with a goal of averaging out just 5 pips over the long term of my trading in a worst case scenario.

So, now, the 'real' situation becomes: 70% win rate averaging 5 pips worst case scenario, with a firm 8 pip loss.

This means that I win 5 pips 7 out of 10 trades for 35 pips, and lose 8 pips 3 times for 24 pips. That leaves me with a net gain over 10 trades of 11 pips, or basically a net gain per trade of 1.1 pips.

So what? That's supposed to make me a trading genius, or something?

No, not at all.

What it does result in are outstanding gains in the long run.

Say I'm trading a $1,000 bank for $1.00 per pip. If I can net, on average 1.1 pips per trade, that's $1.10, i.e. that 11 pips profit over the 10 trades.

Let's say then that, on average, I make just 1.1 pips, $1.10, per trading day.

If I do that 3 days a week, for just 40 weeks a year, then that's a net dollar gain of $132 per year. Sound right? Sound feasible?

Good, because $132 on a $1,000 bank is a yearly return of 13%!

You yawn.... 13%? Really? That's all you got for taking all that dynamic risk?

No, Sparky, that's not all I've got. The risk part stays static at 8 pips, however, my analysis here was making just 1.1 pips per day, and that 1.1 pips was averaged over making just 5 pips profit per trading day. Yeah, just 5 pips.

If you haven't traded before, then you probably have no concept of just how stupid simple it is to make 5 pips per day averaged.

In fact, in the statement of my trading plan, I said that I had a strict 8 pip stop. But I also said that my 'real' profit target was 20 or more pips out. Thus, if I were to make it to 20 pips for each win, those winning numbers would be crazy.

Let's redo that calculation again: I lose 3 out of 10 trades at 8 pips each for a total loss of 24 pips, and I win 13 pips 7 trades out of those 10 trades for a gain of 91 pips. That gives me a net gain over the 10 trades of 67 pips.

The 67 pip gain over 10 trades averages to 6.7 pips per trade. So, on a $1,000 bank at $1 per pip, that makes for an average win of $6.70 per trade.

If I repeat the trading scenario with this new value, then I'll win $6.70 per trade day, 3 days a week, for 40 weeks. That's a total yearly win of $804. And that is an 80% return on risk.

$804 profit per year not enough for you? Fine. Go do some work and gather all your marbles together and trade $100,000 at $100 per pip.

Now, you make $80,400 a year for the same time, and the same crummy little 6.7 average pips a day....

BOOM! And I drop the mic to the floor, and leave the stage.

HOWEVER.... That's ONLY true

IF YOU ABSOLUTELY POSITIVELY FORCE STOP AT 8 PIPS