Risk-Reward Ratio — Trading Wiki

What Risk-Reward Ratio means

The ratio of potential loss to potential gain on a trade. A 1:3 ratio means risking $1 to potentially make $3. Professional traders require minimum 1:2 ratios.

In depth

The risk-reward ratio (R:R or RRR) is a measurement that compares the potential loss on a trade (from entry to stop loss) against the potential gain (from entry to take profit target). Expressed as a ratio like 1:2 or 1:3, it quantifies the trade's payoff structure before entry, enabling traders to make mathematically informed decisions about which trades are worth taking. A 1:2 risk-reward ratio means that for every dollar risked, two dollars of profit are targeted. A 1:3 ratio means three dollars of potential profit for each dollar of risk. This simple metric is one of the most important concepts in trading because it directly determines the win rate required for long-term profitability.

The relationship between risk-reward ratio and required win rate is mathematical: at 1:1 R:R, you need a >50% win rate to be profitable. At 1:2 R:R, you only need a >33.3% win rate. At 1:3 R:R, only >25%. This mathematical reality means that traders with mediocre win rates can still be highly profitable if their average winners are significantly larger than their average losers — a concept known as positive expectancy. Professional traders and hedge funds typically require a minimum 1:2 risk-reward ratio before entering any trade. Some funds mandate 1:3 or higher.

This filter eliminates many potential trades but ensures that the remaining setups have a mathematical edge built in from the start. The calculation is straightforward: divide the distance to your take-profit target by the distance to your stop loss. If your stop loss is $5 below entry and your target is $15 above entry, the R:R is 1:3.

Key points

• Compares potential loss (stop loss) to potential gain (take profit)
• At 1:3 R:R, you only need 25% win rate to be profitable
• Professional traders require minimum 1:2 ratio before entering

Practical tip

Calculate your risk-reward BEFORE entering any trade, not after. Use the 'R-multiple' framework: define your risk per trade (1R), then evaluate all outcomes in terms of R. A +2R winner and a -1R loser gives you a net +1R. Track your average R-multiple across 100+ trades — anything above +0.5R means your strategy has a genuine edge.

Why it matters when you are learning

Risk-reward ratio is the math that separates gambling from trading. Every trade should have the math in your favor BEFORE you enter.

Practising Risk-Reward Ratio on the simulator

Reading about Risk-Reward Ratio and using it are different skills. Try it once in the simulator on an instrument you already follow, write down beforehand what you expect to happen, and check the journal a day later to see whether it played out that way. Educational simulation only — not financial advice.