One of the most important aspects of trading in general is the reward to risk ratio (R:R), but taken alone, it has very little value. The reward to risk ratio, stated simply, is the amount a trader expects to make versus the amount they risked. So if a trader places a $50 trade and they expect a reward of $100, then the R:R ratio is 2:1. It is a more responsible metric in binary trading than “return on investment” which you see quite often, given the “$0 or $100” structure of binary options. For example, if you open a Nadex binary option order ticket and enter 1 contract on the buy side and see “maximum risk” of $47 and “maximum reward” of $53 at the bottom, you have an approximate R:R of 1.1277:1, rounded up (53/47=1.1276595). If the reverse is true, meaning you have a max risk or $53 and a max reward of $47 the your approximate R:R is .8868:1 (47/53=.88679277), which is negative. So what does all this mean? Is a negative R:R always bad?
Well, some would have you believe yes, but that isn’t necessarily the case. A trader’s ability to succeed can only be measured by LONG-TERM profit potential. If Trader 1 has an average loss of $200 but an average of gain of $400, that adds up to a 2:1 R:R. But if this trader’s winning percentage is only 30%, then theoretically, for or every 10 trades the trader gains $1200, but losses $1400 resulting in a net loss of $200.
Flip that same example upside down and Trader 2 has an average loss of $400 and an average gain of $200 for a frowned upon .5:1 R:R, but if Trader 2 wins 70% of the time, then that same set of 10 theoretical trades results in a $200 net gain (7 wins x $200-3 losses x $400=$1400-$1200 or +$200).
Nadex binary options and Nadex spreads calculate the R:R right on your order ticket before you place the order, so it is easy to match up your desired R:R with your historical or expected win percentage. Just make sure you use both, or your trade plan will be incomplete.