Definition
Risk-reward ratio compares the amount at risk (distance to stop loss) to the potential profit (distance to target). A 1:3 risk-reward means risking $1 to potentially make $3. Even with a 40% win rate, a 1:3 ratio is profitable. Professional traders typically require at least 1:2 risk-reward before entering a trade.
functions Formula
Risk-Reward = Potential Loss / Potential Gain
lightbulb Example
Buy stock at $50 with stop loss at $48 (risk = $2) and target at $56 (reward = $6). Risk-reward = 1:3. Even winning only 35% of trades, expected value = 0.35 × $6 − 0.65 × $2 = $0.80 per trade—profitable.
verified_user Key Points
- 1:2 or 1:3 minimum for most traders
- Even low win rates can be profitable with good ratios
- Pre-define risk and reward before entering
- Asymmetric risk-reward is key to long-term success