The risk/reward ratio compares how much a trade can lose with how much it can make. You buy at $50, your stop loss is at $48 and your target is $56: you're risking $2 a share to make $6. That's a reward-to-risk of 3, often written 1:3 ("risk 1 to make 3").
How to calculate it
- Risk = entry − stop loss
- Reward = target − entry
- Reward-to-risk = reward ÷ risk
Using the example: risk = $50 − $48 = $2, reward = $56 − $50 = $6, ratio = 6 ÷ 2 = 3. Try your own numbers in the risk/reward calculator.
The number that matters: break-even win rate
A ratio on its own doesn't tell you whether you'll make money. It tells you how often you need to be right:
Break-even win rate = 1 ÷ (1 + reward-to-risk)
| Reward-to-risk | You need to win at least |
|---|---|
| 1:1 | 50% |
| 1:1.5 | 40% |
| 1:2 | 33% |
| 1:3 | 25% |
| 1:4 | 20% |
That's before fees and slippage, so in practice you need a little more.
Example: two traders
- Trader A takes trades at 1:1 and wins 55% of the time. Over 100 trades risking $100 each: 55 × $100 − 45 × $100 = +$1,000.
- Trader B takes trades at 1:3 and wins 30% of the time. Over 100 trades: 30 × $300 − 70 × $100 = +$2,000.
Trader B is wrong 70% of the time and makes twice as much. That's the point of good risk/reward: you don't need to be right most of the time.
What a "good" ratio really is
A far target gives a great ratio on paper but gets hit less often. A target the stock has no realistic way of reaching makes the ratio meaningless. A sensible target sits at a level price can plausibly reach, such as the next resistance level or a measured move, and the stop sits where the trade idea fails (where to put a stop loss).
So judge a ratio together with an honest estimate of how often that kind of setup works. Many traders look for at least 1:2 on setups that work a decent share of the time.
Mistakes to avoid
- Moving the target further away just to make the ratio look good.
- Moving the stop closer to improve the ratio, so ordinary noise stops you out.
- Ignoring position size. Ratio tells you the shape of the bet; position size decides how much money is on it.
Key takeaway
Work out the reward-to-risk before every trade, then ask whether the setup wins often enough to beat the break-even win rate.
