Risk management is the process of managing (read as reducing) the risk of a trade so that it is more likely to be profitable. Professional traders know that risk management is one of the most important aspects of trading, but it is often overlooked by new traders to their detriment (e.g. their blown up trading account).
The risk to reward ratio is one of the risk management ratios that are used to determine if a trading system is likely to be consistently profitable. Specifically, the risk to reward ratio is a comparison of how much risk a trade has (i.e. how much money it could lose) to its profit potential (i.e. how much money it could make). For example, a risk to reward ratio of 10:20 ticks would indicate that a trade was risking 10 ticks to make 20 ticks. This ratio could also be given as 1:2, or as 50% (calculated as ((10 / 20) * 100) = 50), meaning that the risk is 50% of the potential profit.
Lower risk to reward ratios mean that a losing trade will lose less money that is made by a winning trade. This allows the winning trades to overcome the losses that are incurred by the losing trades. For example, a risk to reward ratio of 25% means that one winning trade can overcome four losing trades. Conversely, a risk to reward ratio of 75% means that one winning trade can only overcome one losing trade.
The risk to reward ratio is often used in combination with some of the other risk management ratios, such as the win to loss ratio (which compares the number of winning and losing trades), and the break even percentage (which gives the number of winning trades that are required to break even).
