What is the Ri sk-Reward Ratio?

What  is  the  Ri sk-Reward  Ratio?

To determine the risk-reward ratio, we need to know the ‘Success’ ratio or probability ratio described in 10.7, above and the ‘Sharpe’ ratio. The latter is the average number of £££'s made on profitable trades, relative to the average number of £££'s lost on unprofitable trades. To express this as a percentage, divide the average £££'s gained on profitable trades by the combined figure of the average number of £££'s gained and lost and then multiply by 100.

For the sake of argument, let us suppose that we have a Success ratio of 2:1 - i.e. a probability of success of 66%. Additionally, we also have a Sharpe ratio of say, 1.5:1 - so that if we risk £40.00 we stand to make £60.00 on the winning trades. The Success ratio tells us that we win 2 out of every 3 trades and the Sharpe ratio tells us that, of the 2 winners, we make 2 x +£60.00 = +£120.00. Our one losing trade of the three costs us -£40.00. On all three trades we risked £40.00 and ended up with a net gain of +£80.00. Therefore, if we divide the net gain by the amount we risked, we arrive at a risk-reward ratio of 2:1. However, a word of caution: all of this assumes that we only trade the setups defined in our plan and that they

     have been thoroughly back and forward tested to determine their probability of success