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Risk/Reward ratio

The Risk/Reward (R/R) ratio is a measure that compares how much you're willing to risk on a trade to how much you expect to gain.
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The Risk/Reward Ratio (R/R ratio) is a simple but powerful tool used by traders and investors to measure the potential gain of a trade compared to the possible loss. It helps answer a basic but critical question:

Is this trade worth the risk I'm taking?

If you’re risking $100 to potentially make $300, your risk/reward ratio is 1:3 — meaning you're risking 1 unit to gain 3.

Understanding the risk/reward ratio is essential for making smart, strategic decisions in the market. Even profitable trades can lead to losses over time if the risk isn’t properly managed. The R/R ratio forces traders to think critically about both sides of a trade — not just what they could gain, but what they could lose.

More importantly, consistent use of the R/R ratio can shift your mindset from chasing profits to managing risk — which is how long-term success in trading is built.

Before entering a trade, many traders calculate their R/R ratio by identifying two key levels:

  • Stop-loss: Where you’ll exit the trade if it goes against you — this defines your risk.
  • Target price: Where you’ll take profits — this defines your reward.

For example, if you're buying a stock at $50:

  • Stop-loss at $48 = $2 risk
  • Target at $56 = $6 reward
  • R/R = 2:6 = 1:3

This helps you decide if the potential gain is worth the downside. It’s especially useful when comparing multiple trade setups — allowing you to pick those with the most favorable payoff profiles.

There’s no single “perfect” ratio, but many successful traders aim for a minimum of 1:2 or 1:3 — risking $1 to potentially make $2 or $3. This way, even if only 40–50% of your trades are winners, you can still be profitable over time.

Some strategies with higher win rates may tolerate lower R/R ratios (like 1:1), while high-risk trades with lower win rates need higher rewards (like 1:4 or more) to be sustainable.

The key is consistency: your strategy should align the R/R ratio with your win rate, market conditions, and personal risk tolerance.

The R/R ratio is a key part of position sizing and risk management. Once you know how much you're willing to lose on a trade (e.g., 1% of your portfolio), you can use the R/R ratio to determine how many shares or contracts to trade.

It also helps remove emotion from the equation. With a planned exit on both sides of the trade, you're less likely to panic when prices move unexpectedly. This encourages discipline, structure, and objectivity, especially in volatile markets.

While the R/R ratio is a helpful planning tool, it doesn’t guarantee success. The market might hit your stop-loss before reaching your target, or reverse entirely after you exit. Also, it doesn’t account for probability — a trade with a 1:5 ratio might look great on paper but only have a 10% chance of hitting the target.

Relying on R/R alone, without considering market context, volatility, and probability, can lead to flawed decisions. It’s most effective when paired with a well-defined trading strategy and a realistic understanding of price behavior.

  • The R/R ratio is about planning, not predicting.
  • A good ratio doesn’t mean a good trade — it must be part of a larger system with sound entry criteria and risk controls.
  • You can be profitable with a low win rate if your reward is large enough compared to your risk.
  • Sticking to your R/R discipline over time can improve your consistency and help preserve capital — which is the name of the game.