Happy Monday, everyone!
I’m going to start off today by telling you a Tale of Two Traders…
Once upon a time in the bustling world of stock trading, there were two traders, Jake and Steve.
Both of these guys had been in the game for about a year, and both were starting to feel like they were on the verge of “making it big.”
Although they started trading at the same time and shared the same feelings about their progress, they were still very different in many ways.
Jake, like many new traders, was all about winning. He believed that the more trades he made, the more chances he had to hit that big winner.
His mindset was simple… If he could just keep throwing darts at the dartboard, some of them were going to hit the bullseye. Or as long as he was right more often than he was wrong, he would be profitable.
He didn’t really care much about risk and just figured he could “manage it later.”
Sometimes he’d chase stocks that looked like they had room to run but never bothered to calculate the downside. “Who cares?” he thought.
He did have a few big wins that fueled his confidence, though, and he began to risk larger and larger amounts on each trade.
Steve, on the other hand, had learned the hard way early on that the market doesn’t care about how confident you are.
Because of that early lesson, he wasn’t concerned with being right all the time. Instead, Steve focused on protecting his account by always using a strict risk-to-reward ratio of 1 to 3.
He entered every trade knowing exactly how much he was willing to lose if things didn’t go his way, and he only took trades where the potential upside was at least three times greater than the risk.
At first, things looked pretty good for both of them.
Jake racked up a series of wins, and his account grew quickly.
Steve…not so much. He was more cautious, so while his account was growing, it wasn’t nearly as fast.
Jake would sometimes tease him: “Dude, you’re leaving money on the table. You gotta be more aggressive!”
But Steve just nodded. He knew he was playing a different game.
Then came the inevitable storm.
A few months in, the market hit a rough patch. Stocks that had been flying high started pulling back.
Jake kept buying dips, thinking the stocks would bounce back. After all, they had before. But this time, they didn’t.
In one particularly bad week, Jake’s confidence turned into panic. His losses started to really add up because he hadn’t set any clear exit points. By the end of the month, Jake had not only given back all his gains but had also taken a deep hit to his account.
Steve? Well, his story was different.
While he wasn’t immune to the downturn, his trades were protected because he stuck to his original plan. He took a few losses, but each one was controlled.
Steve was only risking a small percentage of his account per trade, and since his potential rewards were always much larger than the risks, the losses weren’t nearly as painful as they could have been.
In fact, by the time the market stabilized, Steve had only taken a small step back.
The turning point came a few months later when the market started to pick up again. Jake had lost so much capital that he was trading with a smaller account and didn’t have enough money to take advantage of the emerging opportunities.
His confidence was shattered, and he found himself chasing losses, hoping to recoup what he’d lost.
Steve, meanwhile, was ready. His account was intact, and because he’d followed his risk-to-reward strategy, he wasn’t emotionally rattled.
He patiently waited for high-probability setups—those with a strong 1 to 3 or 1 to 4 risk-to-reward ratio—and when the opportunities came, he was ready to pounce. Within a few months, his account was not only back at its previous level but growing steadily again.
The Moral of the Story?
It’s not about how often you win; it’s about how much you win when you’re right and how little you lose when you’re wrong.
Even if you only win 40-50% of the time, if you’re taking trades with a solid risk-to-reward ratio, you’ll come out ahead in the long run.
Okay, I’m back again…Yes, the story was pretty corny and everybody knew Steve would be the hero, but the lesson here is very important for all traders.
It’s one I brought up last week during my Premarket Prep. I stressed the importance of not going after every trade but instead focusing on only the high risk to reward setups
This way, you don’t waste energy chasing after every single shiny thing…
And when you lose, you lose small, and when you win, you win big.
So make the decision. Do you want to be a Jake? Or a Steve?
Table of Contents
Mastering Risk to Reward in Trading
As a trader, one of the most powerful tools in your arsenal isn’t some obscure technical indicator or a secret trading strategy.
It’s something much simpler yet profoundly impactful—risk to reward.
At its core, the risk-to-reward ratio compares the potential loss you’re willing to take on a trade (risk) with the potential profit (reward).
For example, if you risk $1 to potentially make $3, that’s a 1:3 risk-to-reward ratio.
Readers who grasp this concept and use it tend to survive and thrive.
Those who don’t end up hopping from strategy to strategy, chasing hot tips, and blowing up their accounts every few months.
Why You NEED a Strong Risk-to-Reward Strategy
I’m sure you’ve heard this before: trading is not about being right, it’s about being profitable.
And this is where risk-to-reward really comes into play. The best traders don’t win on every trade, but they position themselves so that even when they lose, the losses are minimal and don’t derail their success.
Here’s how that works in real life:
You can lose more trades than you win and STILL be profitable. If you’re making trades with a 1:3 risk-to-reward ratio, you only need to win 1 out of every 3 trades to break even. That’s the magic of focusing on setups where the upside significantly outweighs the downside.
And speaking of a setup with a great risk to reward ratio, the morning fade pattern is one of those and it’s currently showing up every day.
Read my recent blog post to learn more about it.
Consistency beats luck every time. You can win 50% of your trades, or even 40%, and come out ahead if you’re consistently managing your risk-to-reward ratio.
Because of this, you’re not just sitting there, hoping the next trade works out. Instead, you’re strategically putting yourself in a position where the odds are in your favor over time.
How to Apply Risk-to-Reward
Let’s talk actionable steps.
- Know Your Stop Before You Enter: You need to know exactly where you’ll exit if the trade goes against you before you even click that buy button. This level of discipline is key to sticking to your risk-to-reward ratio.
- Calculate the Potential Reward: Once you know your stop, the next step is to calculate your reward.
What’s your target price?
Don’t assume you’ll hit some crazy target. Be conservative.
If you’re risking $100, make sure there’s at least $200–$300 in potential reward, but don’t just come up with that goal price because it fits the ratio. Be realistic.
If the reward doesn’t justify the risk, walk away. There will always be another trade.
3. Focus on Asymmetry: Here’s where you take your trading to the next level. Always look for setups where the reward significantly outweighs the risk. You’re not just going for 1 to 1 or 1 to 1.5 here.
You’re looking for trades with a 1 to 3, 1 to 4, or an even higher ratio. Successful traders are patient, waiting for those high-quality setups, while others are chasing every little move.
4. Stay Disciplined When Things Get Emotional: When you’re in a trade, emotions can start to cloud your judgment. The stock’s dipping, and you think, “Maybe I’ll just move my stop a little lower,” or it’s spiking, and you think, “I should sell now, even though it hasn’t hit my target.”
No. Stick to your plan. Once you’ve entered the trade, the plan is set. Trust your process and follow through.
Do you have a well-constructed trading plan? If not, you should. Watch my video to learn how to make one.
Stock Traders! Here’s How to Create the Perfect Trading Plan…
5. Review and Adjust: At the end of the week or month, review your trades. How well did you stick to your risk-to-reward ratio? Did you bail on trades too early? Did you let losses run longer than they should have?
Be brutally honest with yourself, and use that feedback to adjust and improve. Trading is a constant learning process, and the more you refine your strategy, the better your results will be.
Do you have a robust trading platform to effectively apply risk-to-reward to your strategy? You’ll need one that allows you to screen for stocks, apply technical indicators, create charts, and more.
StocksToTrade is my top choice. It has the features traders like me look for in a platform. It also has a selection of add-on alerts services, so you can stay ahead of the curve.
Grab your 14-day StocksToTrade trial today — it’s only $7!
My Final Thoughts
I’m not saying risk-to-reward is the only thing that matters in trading, but I can confidently tell you it’s one of the most important pieces of the puzzle.
Without it, you’re just hoping to be right more than you’re wrong. Believe me, the market doesn’t care about hope.
So, commit to understanding and applying risk-to-reward in your trading. It’s not flashy, but it’s reliable. It’ll keep you in the game longer, so you can keep coming back to trade and grow your account.
Stay disciplined, keep learning, and trade smart.
Here at StocksToTrade, we offer many educational resources to keep your trading skills fresh.
Tune in to one of our free live webinars.
They run all day and offer trading tips and tricks, information about how we use our proprietary Oracle system, and other valuable training.
Or register for my StocksToTrade Advisory service…
Every STT Advisory member gets a monthly newsletter with my stock picks, three weekly videos, and more.
Have a great day, everyone. See you back here tomorrow.
Tim Bohen
Lead Trainer, StocksToTrade