The risk/reward ratio tells you how much you stand to make relative to how much you stand to lose on a trade. A 1:2 ratio means risking $1 to potentially gain $2. A 1:3 means risking $1 to potentially gain $3. It is the single most important metric to evaluate before entering any trade.
The Formula
For a long trade: R:R = (Target − Entry) ÷ (Entry − Stop loss)
For a short trade: R:R = (Entry − Target) ÷ (Stop loss − Entry)
Example: Entry $50, stop loss $47, target $59. Risk = $3, reward = $9. R:R = 1:3.
Why It Matters More Than Win Rate
Traders fixate on win rate. The R:R ratio is what actually determines whether a strategy is profitable.
| R:R ratio | Break-even win rate |
|---|---|
| 1:1 | 50% |
| 1:1.5 | 40% |
| 1:2 | 34% |
| 1:3 | 25% |
| 1:4 | 20% |
At a 1:3 ratio, you can be wrong on 75% of trades and still break even. At 1:1, you need to be right more than half the time just to cover commissions and spreads. Improving your R:R has a bigger impact on long-term profitability than improving your win rate.
Common Mistakes
Forcing R:R on a chart. Setting a target at exactly 2× or 3× the risk regardless of whether there's a real technical level there. Targets should sit at logical support or resistance zones — not at arbitrary distances. A target that lands in the middle of a congestion area won't be reached.
Ignoring probability. A 1:10 setup with a 3% hit rate isn't better than a 1:2 setup with a 50% hit rate. R:R and probability of success both matter. A high R:R doesn't compensate for a trade with poor technical structure.
Not accounting for commissions. On a 1:1 trade with $100 risk and $100 reward, a $5 commission on each leg ($10 total) means you need to be right more than 50% of the time just to break even. Always net out trading costs.
Practical Rule
Before entering any trade, ask: if I'm right, do I make at least twice what I lose if I'm wrong? If the chart structure doesn't support a 1:2 setup, pass. There will be a better setup tomorrow.