You buy at $50, put the stop at $47 and set the target at $56. You are risking $3 to make $6. That is a 1:2 risk-reward ratio, and it is the number that decides how often you have to be right.
What a risk-reward ratio is
Risk is the distance from your entry to your stop. Reward is the distance from your entry to your target. The risk-reward ratio is reward divided by risk, written as 1 to that figure. One unit of risk on the left, the reward multiple on the right.
For the trade above, risk is $50 minus $47, or $3. Reward is $56 minus $50, or $6. Divide $6 by $3 and you get 2, so the ratio is 1:2.
Note the direction. Some sources write the same trade as 0.5, dividing risk by reward. This article uses reward divided by risk throughout, so a bigger number is always a wider target relative to the stop.
Why the risk-reward ratio matters
Win rate and risk-reward together
Two numbers decide whether a strategy makes money: how often it wins, and how much a win pays. Neither is informative alone.
Take 100 trades on each of three sets of numbers.
| Win rate | Average win | Average loss | Result over 100 trades |
|---|---|---|---|
| 40% | $200 | $100 | 40 x $200 minus 60 x $100 = +$2,000 |
| 50% | $100 | $100 | 50 x $100 minus 50 x $100 = $0 |
| 60% | $100 | $200 | 60 x $100 minus 40 x $200 = minus $2,000 |
The trader who wins 40% of the time finishes ahead of the one who wins 60%, because the size of each result outweighs the count.
The minimum risk-reward: the breakeven line
For any win rate there is one ratio at which the strategy makes nothing. Call the win rate W. The breakeven ratio is (1 minus W) divided by W.
| Win rate | Ratio at exact breakeven |
|---|---|
| 30% | 2.33 |
| 40% | 1.50 |
| 50% | 1.00 |
| 60% | 0.67 |
| 70% | 0.43 |
Read the table as a floor, not a goal. At a 40% win rate and a 1.5 ratio you make nothing at all before costs, and after brokerage you lose. Whatever ratio you decide to require, it has to sit above the line, and it has to sit far enough above that the first bad run does not put you underneath it.
The same relationship runs the other way. For a ratio of R, the breakeven win rate is 1 divided by (1 plus R).
| Risk-reward ratio | Breakeven win rate |
|---|---|
| 1:1 | 50.0% |
| 1:1.5 | 40.0% |
| 1:2 | 33.3% |
| 1:3 | 25.0% |
| 1:4 | 20.0% |
Why a wider risk-reward ratio costs win rate
A target twice as far away requires price to travel twice as far, so it is reached less often. Win rate and ratio move against each other, and any comparison that holds one fixed while improving the other is describing two different strategies rather than an improvement to one.
This is why the useful figure is expectancy, which combines them. In R units, expectancy is the win rate times the reward multiple, minus the loss rate times one. At a 40% win rate and a 2 ratio: 0.4 times 2, minus 0.6 times 1, is plus 0.2R per trade.
How to calculate risk-reward on a trade
- Set the entry price.
- Set the stop at the price that says the trade idea was wrong. Risk equals entry minus stop.
- Set the target at a level the chart supports. Reward equals target minus entry.
- Divide reward by risk.
A worked example
The trade below is hypothetical and the prices are illustrative.
A stock has support at $175, resistance at $195, and a recent swing low at $172. You buy the bounce off support at $176, put the stop at $171 below the swing low, and set the target at $193, just under resistance.
Risk is $176 minus $171, or $5. Reward is $193 minus $176, or $17. Divide and the ratio is 3.4.
The breakeven win rate for a 3.4 ratio is 1 divided by 4.4, or 22.7%. Take that trade repeatedly and win 40% of the time and expectancy is 0.4 times 3.4, minus 0.6, or plus 0.76R per trade.
Both of those figures depend on the stop and the target being real levels. Moving the target to $210 because it improves the ratio does not improve the trade; it moves the number without moving the price.
Setting your own minimum risk-reward ratio
The ratio you require is a decision, not a fact. What the arithmetic gives you is the consequence of each choice.
A 1:1 requirement needs a win rate above 50% to make anything, which leaves no room for a run of losses. A 1.5 requirement needs above 40%. A 2 requirement needs above 33.3%. At exactly one win in three it breaks even. A strategy that is wrong twice as often as it is right makes nothing at a ratio of 2, and needs a ratio above 2 to come out ahead. A 3 requirement needs above 25%.
Set the level, write it into your rules, and record it before each entry rather than after.
The pre-trade risk-reward checklist
Five things to have on the screen before the order goes in.
- The entry price is a number, not a range.
- The stop sits at a level the chart defines, so you can say what breaking it means.
- The target sits below the first opposing level rather than through it.
- The resulting ratio clears the minimum you set above.
- The win rate you are assuming is one your own closed trades support, not one that makes the arithmetic work.
Trades worth skipping
Four reasons to pass, each a failure of one checklist item. The ratio falls below your minimum. There is no level that defines the stop, so risk is whatever you decide it is after the fact. The target requires a move with nothing on the chart to support it. Or another setup in front of you clears the same bar with a shorter distance to its stop.
Passing costs nothing except the trade you would have taken, and the checklist is the thing that makes passing a decision rather than a reaction.
What limits the risk-reward ratio you can get
Market conditions. A trending market keeps making higher highs, so a distant target has somewhere to come from. In a range, the target runs into the top of the range, and the achievable reward is the width of the range minus your entry.
Timeframe. A longer holding period gives price more sessions in which to travel, so a wider target is reachable. It also means more overnight gaps and more time for the reason you entered to expire.
The structure of the setup. The distance to the nearest opposing level is the real cap on the target. A setup with clear support below the entry and nothing overhead until far above it produces a high ratio because of where the levels sit, not because of how you feel about the chart.
Improving your risk-reward without inventing numbers
A better entry
Entry $50, stop $45, target $60 is $5 of risk against $10 of reward, a ratio of 2. Waiting for price to come back to $48 with the same stop and target gives $3 of risk against $12 of reward, a ratio of 4.
The ratio doubled and the trade did not change. What changed is the price you paid, and the cost of waiting is that price may not come back.
A wider target
Entry $50, stop $47, target $55 is $3 against $5, a ratio of 1.67. Holding for $59 instead is $3 against $9, a ratio of 3. The cost is the trades that reach $55 and turn before $59.
A tighter stop
Entry $50, stop $44, target $60 is $6 against $10, a ratio of 1.67. Moving the stop to $47 is $3 against $10, a ratio of 3.33.
This is the one to be careful with. A stop is a price at which your reason for the trade has failed. Moving it closer to improve a ratio moves it to a price the stock reaches while your reason is still intact. The strategy that results has a far lower win rate than the one you measured.
Common risk-reward mistakes
- Calculating it after the entry. The ratio is a filter. Worked out after you are in the position, it is a description.
- Targets that ignore the chart. A target above a resistance level counts reward you have to break through a wall to collect.
- Tightening the stop for the arithmetic. Covered above. It improves the number and damages the strategy.
- Exiting early, repeatedly. Planning for 3 and closing at 1 gives you the win rate of the wide target with the payoff of the narrow one, which is the worst of both. Either honour the target or plan a scale-out and record it as the plan.
- Treating a high ratio as a reason on its own. A 1:5 trade with a 10% chance of reaching the target has an expectancy of 0.1 times 5, minus 0.9, or minus 0.4R. The ratio is only half the calculation.
Risk-reward quick reference
| Risk-reward ratio | Breakeven win rate | Expectancy at a 40% win rate |
|---|---|---|
| 1:1 | 50.0% | minus 0.2R |
| 1:1.5 | 40.0% | 0.0R |
| 1:2 | 33.3% | plus 0.2R |
| 1:3 | 25.0% | plus 0.6R |
| 1:4 | 20.0% | plus 1.0R |
Every figure in the right-hand column is 0.4 times the ratio, minus 0.6.
Measuring your risk-reward in Swingfolio
Planning a ratio and achieving it are two different records, and the difference between them is what the record is for.
While you enter a trade, Swingfolio shows the risk-to-reward ratio from your entry, stop and target as you type them, alongside the trade's risk as a percentage of your portfolio. After the trade closes, the Plan vs Actual panel on the trade detail page puts up to four pairs side by side. Planned R-multiple against achieved. Target price against exit price. Stop against exit. Holding period against your time stop. The R-multiple row is labelled met, short by a percentage, far short or loss. The other rows carry their own verdicts, such as target hit or time stop hit.
The exit capture chart takes it further. For every closed trade that exited above its entry, it works out, from daily price history, how much of the peak favourable move you captured. Trades that exited below entry get a downward bar instead: how much of the worst drawdown you sat through before exiting. A page of upward bars reaching 40% of the available move means targets set too far away or exits taken too early. The Plan vs Actual rows tell the two apart.
There is also a risk-reward calculator if you want to check a ratio before the trade exists.
Record the planned ratio on your next ten trades and compare it with the achieved column. Start the 30-day trial.