Risk-Reward Ratio Explained

What the risk-reward ratio is and how to calculate it

The risk-reward ratio expresses the size of your potential loss relative to your potential gain on a single trade. You define three prices before entering: the entry, the stop-loss (where the idea is wrong), and the take-profit target. Risk is the distance from entry to stop; reward is the distance from entry to target. The ratio is reward divided by risk, expressed against a risk unit of 1.

Worked example: you buy at 100, place your stop at 95, and set your target at 115. Your risk is 5 points (100 - 95) and your reward is 15 points (115 - 100). That is a 1:3 risk-reward ratio — you are risking 1 unit to potentially make 3. The ratio is identical whether you measure in points, ticks, or currency, as long as both legs use the same unit. Crucially, the ratio describes the plan; it does not predict whether price will actually reach the target or stop.

Notation: risk:reward (1:3) vs reward:risk (3:1)

The standard convention is risk-first — risk:reward — so the '1' is your unit of risk and the second number is the reward, as in 1:3. Many traders and platforms invert this and quote reward-to-risk (3:1) for the exact same trade. Both describe the same setup, but mixing them up is a common source of confusion and can make a weak trade look strong. Whenever you read a ratio, confirm which number is the risk before drawing any conclusion.

Why the ratio is meaningless without win rate

A ratio on its own tells you nothing about profitability. What matters is whether your win rate clears the breakeven win rate that the ratio implies. The formula is: breakeven win rate = risk / (risk + reward). So a 1:3 trade only needs to win about 25% of the time to break even before costs, while a 1:1 trade needs roughly 50%. If your strategy wins less often than its breakeven rate, even an attractive-looking ratio loses money over time.

• 1:1 — breakeven win rate ~50%
• 1:2 — breakeven win rate ~33%
• 1:3 — breakeven win rate ~25%
• 1:5 — breakeven win rate ~17%
• Reminder: these are pre-cost breakeven points. Spreads, commissions, and slippage raise the win rate you actually need.

Expectancy: what actually determines long-term results

Profitability over many trades is captured by expectancy, which weights your average win and average loss by how often each happens: expectancy = (win rate x average win) - (loss rate x average loss). This is why a 40% win rate at 1:3 can outperform a 70% win rate at 1:1 — the larger, less frequent wins more than offset the more numerous small losses. A 'good' risk-reward ratio is therefore not a fixed number like 1:2; it is whatever ratio, combined with your realistic win rate and after costs, produces positive expectancy. Note that expectancy is a long-run statistical average, not a promise about any single trade or short sequence.

Setting stops, targets, and position size properly

Anchor your stop and target to the market, not to a number you want to hit. Place the stop where the trade idea is invalidated — beyond a structural level, swing point, or a volatility buffer such as a multiple of ATR — and place the target at a level price can realistically reach, like the next significant support or resistance. Avoid working backwards by widening the target or tightening the stop just to manufacture a 1:3; that is curve-fitting and distorts the real ratio. Stops set too tight get hit by normal noise, while stops set too wide create oversized losses. Finally, the ratio is not a substitute for position sizing: risking a fixed fraction of equity per trade (for example 1%) and thinking in R-multiples — outcomes expressed in units of risk, where a 1:3 winner is +3R — is what controls drawdown through inevitable losing streaks.