Glossary
Risk-reward ratio
The distance from entry to stop compared with the distance from entry to target, used to judge whether a trade is worth taking.
The risk-reward ratio compares how much a trade stands to lose if it fails with how much it stands to gain if it works, based on the planned stop and target. A trade that risks $1 a share to make $3 has a risk-reward of 1:3. Traders use it before entering a position to decide whether the potential payoff justifies the risk, and to see what win rate the strategy needs to break even.
How it works
Conventions differ: some traders write risk first (1:3), others quote reward-to-risk (3:1 or "3R"). Both describe the same trade.
Why win rate matters too
A good ratio alone does not make a profitable strategy. What counts is the combination of payoff and how often it pays:
At 1:3, you break even winning 1 ÷ 4 = 25% of trades, before costs. At 1:1, you need 50%. A strategy with 1:3 trades that wins only 20% of the time loses money; one with 1:1 trades that wins 60% makes money.
What to watch for
- Targets are guesses. Stretching a target to make the ratio look better usually lowers the chance of reaching it.
- Stops can be skipped. Gaps and fast markets can fill a stop well below its level, so real losses can exceed the planned risk.
- Costs count. Commissions, spreads and Slippage shrink the reward and enlarge the risk, which matters most on small, frequent trades.