Risk/Reward Ratio

The risk/reward ratio compares how much you could lose on a trade with how much you could gain. If you risk $100 to make $300, your risk/reward is 1 to 3 (often written 1:3, or as a reward to risk of 3). It is one of the most quoted numbers in trading, and one of the most misunderstood. A high ratio alone does not make a good trade; what matters is the ratio combined with how often trades like it actually win.

How to calculate it#

Risk = |Entry − Stop|
Reward = |Target − Entry|
Reward to risk = Reward ÷ Risk

Many traders measure results in R multiples, where 1R is the amount risked. A trade that gains $4.50 when risking $1.50 is a +3R trade. See Trading Journal.

Risk/reward and win rate go together#

The ratio you need depends on how often you win. The break even win rate for a given reward to risk is:

Break even win rate = 1 ÷ (1 + Reward to risk)

A strategy with a 1:3 risk/reward profits if it wins more than 25% of the time, ignoring costs. A strategy with a 1:1 ratio needs to win more than half the time. Neither is automatically better. See Expectancy and Win Rate and Payoff Ratio.

The trap of chasing high ratios#

It is easy to make any trade look like 1:5 by placing a tight stop and a distant target. But a tight stop gets hit more often, and a distant target is reached less often, so the win rate falls. The ratio on paper rises while the real expectancy may not change, or may get worse.

Setting realistic targets#

Targets should come from the market, not from a wish for a particular ratio:

• The next significant resistance or support level. See Support and Resistance.
• A measured move from a pattern.
• A multiple of ATR suited to your holding period.
• Liquidity pools above highs or below lows. See Liquidity in Smart Money Concepts.

Then check: does the realistic target, compared with the logical stop, give a ratio that makes sense for your strategy's win rate? If not, skip the trade rather than moving the stop or target to force it. See Profit Targets.

Using risk/reward in your plan#

1. Set a minimum reward to risk based on your historical win rate.
2. Calculate it before every trade as part of your Pre-Trade Checklist.
3. Track actual R multiples in your journal to see whether targets are realistic.

Common mistakes#

• Treating a high ratio as a high quality trade.
• Tightening stops to improve the ratio.
• Ignoring win rate when judging a strategy.
• Moving targets further once in a trade without a reason.

Frequently asked questions#

What is a good risk/reward ratio?#

It depends on your win rate. Many traders aim for at least 1:1.5 or 1:2, but a strategy with a high win rate can be profitable at lower ratios.

How do you calculate the risk/reward ratio?#

Divide the distance from entry to target by the distance from entry to stop.

Is a 1:3 risk/reward always better than 1:1?#

No. A 1:3 trade with a 20% win rate loses money, while a 1:1 trade with a 60% win rate makes money. Ratio and win rate must be considered together.

Next, cap your losses per day with a Maximum Trade Risk and Daily Loss Limits.