The best traders don't just look for setups. They look for setups with the right risk-reward ratio.
A 1:2 risk-reward ratio means you're risking $1 to make $2. A 1:3 ratio means you're risking $1 to make $3. These numbers might seem simple, but they're the foundation of profitable trading.
Most traders focus on win rate, but that's only half the equation. A trader with a 40% win rate and a 1:3 risk-reward ratio can be more profitable than someone with a 60% win rate and a 1:1 ratio.
📊 What Is Risk-Reward Ratio?
Risk-reward ratio (also called R multiple) compares:
- Risk: How much you stand to lose (entry to stop loss)
- Reward: How much you stand to gain (entry to target)
A 1:2 ratio means your potential profit is twice your potential loss. A 1:3 ratio means your potential profit is three times your potential loss.
🔢 How to Calculate Risk-Reward
The formula is straightforward:
- Risk = |Entry Price - Stop Loss Price|
- Reward = |Target Price - Entry Price|
- R Multiple = Reward ÷ Risk
For example:
- Entry: $100
- Stop: $95 (risk = $5)
- Target: $110 (reward = $10)
- R Multiple: 2.0 (1:2 ratio)
You can use a free risk-reward calculator to do this instantly for any setup.
🎯 What's a Good Risk-Reward Ratio?
Most professional traders look for:
- Minimum 1:2 for swing/position trades
- 1:3 or higher is considered excellent
- 1:1.5 can work if your win rate is high enough
But here's the key: The ratio alone doesn't tell the whole story. You need to consider:
- Your win rate
- Market conditions
- Your trading style
A 1:5 ratio with a 15% win rate is worse than a 1:2 ratio with a 50% win rate.
⚠️ Why Risk-Reward Matters
Without evaluating risk-reward, you might:
- Take trades where you risk more than you gain
- Set targets that are too far (lowering win rate)
- Set targets that are too close (limiting profit)
- Make emotional decisions about exits
With proper risk-reward analysis, you:
- Only take trades with positive expectancy
- Set realistic targets based on technical levels
- Make objective decisions about trade quality
- Build a system that works over time
🛠️ Using a Risk-Reward Calculator
I've built a free risk-reward calculator that shows you:
- Your risk amount
- Your reward amount
- R multiple (risk-reward ratio)
- Risk percentage (relative to entry)
- Reward percentage (relative to entry)
Just enter your entry, stop loss, and target prices, and you'll instantly see if the setup is worth taking.
📈 Real-World Example
Let's say you're looking at a stock setup:
- Entry: $50
- Stop Loss: $48 (4% risk)
- Target: $56 (12% reward)
- R Multiple: 3.0 (1:3 ratio)
This is an excellent setup. Even with a 40% win rate, you'd be profitable:
- 40% of trades win $6 (average win)
- 60% of trades lose $2 (average loss)
- Expectancy: (0.4 × $6) - (0.6 × $2) = $1.20 per trade
🧠 Common Risk-Reward Mistakes
Mistake #1: Chasing unrealistic ratios
- Setting 1:10 targets that never hit
- Lowering your win rate for the sake of a high ratio
- Fix: Set targets based on technical levels, not arbitrary ratios
Mistake #2: Ignoring win rate
- Focusing only on the ratio, not your actual win rate
- A 1:5 ratio with 10% wins is terrible
- Fix: Calculate your expectancy: (Win Rate × Avg Win) - (Loss Rate × Avg Loss)
Mistake #3: Moving stops to improve ratios
- Widening your stop loss just to get a better ratio
- Your stop should be based on technical analysis, not math
- Fix: Let technical analysis determine your stop, then evaluate the ratio
Mistake #4: Not considering market context
- Using the same ratio expectations in all market conditions
- Trending markets might allow lower ratios
- Fix: Adjust your expectations based on market volatility and structure
✅ Risk-Reward Best Practices
- Calculate before entering: Know your ratio before you take the trade
- Set targets based on technicals: Not arbitrary ratios
- Consider your win rate: Higher win rates can accept lower ratios
- Use position sizing: Combine risk-reward with proper position sizing
- Track your actual ratios: Review your trades to see if you're hitting targets
🎯 The Bottom Line
Risk-reward ratio is one of the most important metrics for evaluating trades. But it's not the only metric. You need to combine it with win rate, position sizing, and market context.
The goal isn't to find the highest ratio possible. It's to find setups where the ratio, combined with your win rate, gives you positive expectancy over time.
Use a risk-reward calculator to quickly evaluate setups, and focus on building a system that works consistently.
Trade smart,
– PatrickWS
