What the risk reward ratio is
The risk reward ratio compares what you stand to lose with what you stand to gain on a trade. It is written as 1:2, which means you risk 1 unit to potentially make 2 units. The ratio is worked out from three prices you choose before entering: the entry, the stop loss and the target.
The risk is the distance from the entry price to the stop loss. The reward is the distance from the entry price to the target. Divide the reward by the risk and you have the ratio.
A simple example: you buy at $100, set the stop loss at $95 and the target at $110. The risk is $100 − $95 = $5, and the reward is $110 − $100 = $10. The ratio is $10 ÷ $5 = 2, written as 1:2.
The ratio is a planning tool, not a prediction. It tells you whether the trade is worth taking if your analysis is right — it says nothing about whether your analysis will be right.
- Risk = distance from entry to stop loss.
- Reward = distance from entry to target.
- Ratio = reward ÷ risk, written as 1:2.
The formula, step by step
Step one is the risk. Subtract the stop loss from the entry price for a long trade, or the entry price from the stop loss for a short trade. Use the absolute distance — the number is always positive.
Step two is the reward. Subtract the entry price from the target for a long trade, or the target from the entry price for a short trade. Again, use the absolute distance.
Step three is the division. Divide the reward by the risk. If the reward is $10 and the risk is $5, the ratio is 2, written as 1:2. If the reward is $7.50 and the risk is $5, the ratio is 1.5, written as 1:1.5.
Do the calculation before you enter the trade, not after. Once you are in a trade, it is tempting to move the target further away to make the ratio look better — but a target that was never realistic does not become realistic because you wrote it down.
- Risk = |entry − stop loss|.
- Reward = |target − entry|.
- Ratio = reward ÷ risk.
- Work it out before entering, not after.
What the ratio means for your win rate
The ratio decides the win rate you need to break even. The formula is: break-even win rate = 1 ÷ (1 + R), where R is the reward multiple. With a 1:1 ratio you need to win 50% of your trades. With a 1:2 ratio you need about 33.3%. With a 1:3 ratio you need 25%.
This is why traders care about the ratio. A 1:2 ratio means you can be wrong twice as often as you are right and still break even — before fees. That takes a lot of pressure off each individual trade.
Fees raise the bar slightly, because every trade costs something to open and close. After fees, a 1:2 ratio needs a little more than 33.3% wins. The effect is small on large trades and larger on small ones, so include fees when the numbers are tight.
The win rate maths assumes every trade has the same ratio, which is rarely true in practice. Treat the break-even figure as a guide for judging whether a ratio is worth aiming for, not as a precise forecast of your results.
- Break-even win rate = 1 ÷ (1 + R).
- 1:1 needs 50% wins; 1:2 needs 33.3%; 1:3 needs 25%.
- Fees push the required win rate slightly higher.
What counts as a good ratio?
There is no universal good ratio, but a ratio of 1:2 or better is a common aim among traders — the potential win is at least twice the potential loss. Ratios below 1:1 mean you lose more on losers than you make on winners, which demands a very high win rate to survive.
A high ratio is not automatically better. A 1:5 ratio looks excellent on paper, but if the target is so far away that the price almost never reaches it, the ratio is meaningless. The target has to be a price the market can plausibly reach.
Judge the ratio together with the setup. A realistic target, a sensible stop loss and a ratio of 1:1.5 can be a better trade than a distant target and a ratio of 1:4 on a weak setup.
If you cannot find a trade with an acceptable ratio, the right move is often to wait. Forcing a trade with a poor ratio just to be in the market is how accounts get worn down a little at a time.
The bottom line
The risk reward ratio is a filter, not a promise. It helps you skip trades where the potential loss outweighs the potential gain, and take trades where the maths is on your side.
Use it before every trade: entry, stop, target, ratio — then decide. A good ratio does not make a bad setup good, and a poor ratio can turn a good idea into a bad trade.
Trading involves risk, and no ratio can remove it. What the ratio does is make the risk explicit, so you take it with your eyes open.
