What is Risk to reward ratio (RR)?
Whenever you are investing in a stock, you should take care of the risk to reward ratio. The risk to reward ratio should be reasonably good since there is always an underlying risk of losing money. In order to be in profit and avoid making losses, you should be able to calculate the risk involved in your investment. The probability of your trade going right should be higher to your trade ending up in loss. That is, you should be able to calculate the loss even before you trade. Every trader has his own loss taking capacity. But that is different from risk to reward ratio.
Here’s an example:
Coal India Ltd hits 315 which is its strong support. As according to the weekly charts, it is evident that the stock gives a spurt everytime it touches the zone of 300-320. This is something you have to study when you invest. If you are aware of the price action of the stock, then you will never be in loss.
Suppose you buy 1000 shares @ 315. But before you do so, you should be able to draw a line where you would sell your shares if the stock moves in a downtrend.
Suppose you determine 300 to be your SL (stop loss). Below which you would sell off your shares and take the loss.
Have a look at the charts. It will give you a good idea of what kind of stock analysis needs to be done before you invest.
From the chart above, it is clearly evident that whenever COALINDIA LTD has gotten into the zone of 300-320, it has taken support at 300 levels… Now you should know that if the fall of a stock takes support at a certain level more than thrice on weekly basis, that level becomes a strong support and it provides you with a good opportunity to invest.
From the chart above, you can see that the stock has taken support at 302 level and a rally has taken place on a weekly basis and touched 360 levels.
Now since you know how you can buy and sell depending on the supports in the history of the stock, similarly, you should also be able to figure out the resistances of the stock – the point from where the stock generally reverses.
From the charts above, we can confer that the resistance of this particular stock lies at 360 levels from where it generally plunges downwards. So, if you are a positional trader, you should very well know as to when you could sell.
So now lets calculate the loss (considering the uptrend to fail):
15rupees x 1000 shares = 15000/-
Current price of CoalIndia: 361/-
361 – 315 = 46
46 x 1000 = 46000/-
So, you see the expected profit is 46000/- which is 3 times that of the calculated loss.
Here, risk to reward ratio is 1:3
If you are the kind of trader who looks for RR (risk to reward ratio), then use it at all times.
For Positional trading:
For Swing trading:
Keep in mind that all your positional trades should have the potential to give the best. If it makes loss then it should not be more than 1 rupee but if it makes profit, it should make 10 rupees.