Understanding Risk-Reward Ratio
The risk-reward ratio compares the potential loss of a trade to its potential profit. A ratio of 1:2 means you risk $1 to potentially make $2. This ratio is fundamental to profitable trading because it allows you to be profitable even with a low win rate.
The Formula
Risk-Reward Ratio = (Entry Price - Stop Loss) / (Target Price - Entry Price). Example: Buy at $100, Stop at $95, Target at $110. Risk = $5, Reward = $10. R:R = 1:2. You can lose more trades than you win and still be profitable with favorable ratios.
Win Rate vs Risk-Reward
Breakeven win rates: 1:1 R:R needs 50%+ win rate. 1:2 R:R needs 34%+ win rate. 1:3 R:R needs 25%+ win rate. 1:4 R:R needs 20%+ win rate. Higher R:R ratios allow lower win rates while maintaining profitability. Professional traders often target 1:2 or better.
Practical Application
Before entering any trade: Define your stop loss, Define your target, Calculate R:R ratio, Reject trades with poor R:R (<1:1.5), Let winners run to target, Cut losers at stop without hesitation. Discipline in execution is key.
Key Takeaways
Target minimum 1:2 risk-reward ratio. Don't chase trades with poor R:R. Let winners run, cut losers quickly. Combine with proper position sizing. High R:R compensates for low win rates. Never move stops to avoid losses. Use our Risk-Reward Calculator.