So let's say trader A plans to buy Apple shares at $100 per share and plans to sell it at $150.
However, for this particular trade of Apple, you're either going big or going home.
Trader A tells himself, “If Apple drops to $0, I’ll still hold it!”
You can see that trader A’s entire risk on this trade is a full $100 and the profit in his trade would be $50.
Now, divide the potential risk ($100/$100) and the potential profit ($50/$100) and you can see that trader A is actually risking $1 to make $0.5
From a risk to reward standpoint, this is not too attractive if you ask me…
Now, let’s compare this to another trader who bought Apple shares at $100 and sold it at $110.
The potential profits are much smaller but this trader now has a stop loss or a predetermined exit price.
Let's say that trader B’s exit price is $95.
Now ask yourself…
What is this percent risk per trade?
Subtract $100 (entry price) from $95 (stop loss price), and you get -$5 risk of the trade.
How about the reward per trade?
Subtract $100 (entry price) to $110 (take profit price) and you get a potential +$10 reward of the trade.
Now, you can see that he's risking $5 to make $10!
And if you just keep things simple, you’ll realize that trader B is actually risking $1 to make $2
Compared to the trader earlier who has a bigger potential profit of $50, but has a bigger risk of $100, basically risking $1 to make $0.5
Which is a better trader?
If you ask me, from an R multiple standpoint, trader B did a better trade.
You can look at trader B in two ways: