Accuracy Rate and Risk Reward Ratio - A Winning Combination

Apurva Sheth
Last time, I wrote about accuracy rate and the fixation around it. Accuracy rate is nothing but the percentage of profitable trades out of the total recommendations.

A lot of people think you need high accuracy rates for profitable trading. This isn't true at all. You can make money with a low accuracy rate provided you have a good risk reward ratio.

risk reward ratio refers to how many rupees your winning trade will earn for every rupee of risk you take. Unfortunately, risk reward ratio gets little attention from retail traders.

Today, I will cover risk reward ratio and the importance of combining it with accuracy rate to build an effective trading strategy.

We measure risk reward ratio by dividing the reward (Target - Entry Price) by the risk (Entry price - Stoploss).

You can use the accuracy rate of your trading system to identify the minimum risk reward ratio you need in your trades. You can use this simple formula:

Let's say you have a trading system that is right only 40% of the time. The minimum risk reward ratio required to breakeven would be 1.50.

One can use this formula to evaluate different trading systems. A low accuracy rate does not necessarily mean the strategy is bad. If the risk reward ratio for the strategy is higher than the minimum required ratio, then the strategy is profitable and can be used.

On the other hand, a high accuracy rate does not mean that the strategy will be profitable. In fact, it is very easy to create a strategy with a 90% accuracy rate. Simply set the profit target one rupee away from the entry price and set the stoploss ten rupees away. This strategy would easily close 90% of its trades as winners as the profit target is very close to the current price and the stoploss is far off.

But do you think this strategy would be very profitable on a net basis?

I doubt it.

The profit per trade would be small compared to the losses incurred when the system is wrong. The profits from all those small winning trades would be offset by the rare but large losing trades. One would actually need an accuracy rate even higher than 90% to be profitable on a net basis using this strategy.

So one should never look at accuracy rates or risk reward ratios in isolation. Always look at both in relation to each other to build a profitable strategy.

The table below shows several accuracy rates and risk reward ratios to produce breakeven results. To be profitable, one need to have an accuracy rate higher than the breakeven accuracy rate next to the preferred risk reward ratio.

Minimum Accuracy Rate Minimum Risk Reward Ratio
20% 4.00
30% 2.33
40% 1.50
50% 1.00
60% 0.67
70% 0.43

For example, if your system has an accuracy rate of 50%, you need a risk reward ratio higher than 1.00 to be profitable. On the other hand, if you pick trades with a risk reward ratio of 2.33, you need an accuracy rate higher than 30%.

At Swing Trader, we focus on combining the accuracy rate and the risk reward ratio to develop a winning strategy.

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2 Responses to "Accuracy Rate and Risk Reward Ratio - A Winning Combination"
Mohammad Wasim Akhtar
26 Jun, 2020
This r.r ratio looks good in book good but practically we do not get this r.r ratioLike 
Asha Bansal
15 Sep, 2016
Hi, very informative article. I am 28 years old and I am searching for good investment options. I just came to know about peer to peer lending as an emerging platform in India and wanted your views on that. Like 
We request your view! Post a comment on "Accuracy Rate and Risk Reward Ratio - A Winning Combination". Click here!