What is Risk-Reward Ratio in Trading?
The risk-reward ratio (R:R) compares the distance to your stop loss (risk) against the distance to your take profit (reward). A 1:2 ratio means you risk $1 to potentially make $2.
How It Works
Risk-reward is calculated before entering a trade. If your entry is at 1.1050, stop loss at 1.1025 (25 pips risk), and take profit at 1.1100 (50 pips reward), your R:R is 1:2. The power of a favorable risk-reward is mathematical. With a 1:2 R:R, you only need to win 34% of your trades to break even. With 1:3, you need just 25%. This means you can be wrong more often than you're right and still be profitable. Many traders aim for at least 1:1.5 or 1:2, though the right ratio depends on your strategy and win rate. Anything below 1:1 requires a very high win rate to be sustainable, which is harder to maintain over time.
Why It Matters
Risk-reward forces you to think about the quality of a setup before entering. If the nearest support offers only 15 pips of upside but your stop loss needs to be 30 pips away, the R:R is 1:0.5. The trade may not be worth taking regardless of how good the signal looks.
Common Mistake
Chasing high ratios without checking if the target is realistic. A 100-pip target on a pair with a 50-pip daily ATR may look great on paper but rarely fills in a single session. Risk-reward only works when the target has a structural reason to be reached.
Example
You take 100 trades with a 1:2 risk-reward, risking $100 per trade. You win 40 trades ($8,000 in gains) and lose 60 ($6,000 in losses). Net profit: $2,000, despite winning only 40% of the time.
Stoic Insight
The Stoics valued wisdom: seeing things as they are, not as you wish them to be. An honest risk-reward assessment asks whether the target is structurally supported, not whether the ratio looks impressive in a trade journal.
Related Terms
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