The Reward/Risk Ratio is simply a way of expressing the potential reward (profit) on a trade, relative to the potential risk (loss).
You might see it expressed in one of two ways..
A 2:1 Reward:Risk would mean that for each dollar you're risking, your potential profit is 2 dollars.
If your stop loss level is 20 pips, then your take profit would be 40 pips.
The R Multiple
Derived from the ratio, a 2R trade would simply be 2:1, and a 3.5R trade would be 3.5:1 (or 7:2 in mathematical terms).
The Reward/Risk ratio is important for many reasons that are often overlooked.
Calculating your trade size
It's essential that you calculate your stop less level before entering a trade in order to effectively manage your risk and money.
If you decide to risk 1% of your account on each trade, then you'll need to calculate the correct order size based on your stop loss to ensure that you're consistently implementing your risk management.
As an example, if you open a 1 Lot (100k base currency) trade with a 30 pip stop loss, it wouldn't make sense to then open another 1 Lot trade with a 60 pip stop loss, as your loss would be twice as much! In this case, you'd need to halve your order size to 50k.
Deciding if a trade is worth it
If your strategy is profitable 65% of the time, then it wouldn't make sense to open a 0.5:1/0.5R trade as you wouldn't make any money in the long run.
Remember - it's essential that you calculate the Reward:Risk ratio before you open a position.