Risk-Reward Ratio: The Math Behind Profitable Trading

Here's a secret most beginners don't understand: you don't need to win most of your trades to be profitable. What matters is how much you win when you're right versus how much you lose when you're wrong. That's the risk-reward ratio—and it might be the most important concept in trading.

What Is the Risk-Reward Ratio?

The risk-reward ratio (R:R) compares the potential profit of a trade to its potential loss. It answers a simple question: "How much can I gain compared to how much I might lose?"

Formula:

Risk-Reward Ratio = Potential Loss : Potential Gain

Or expressed as a single number:

R:R = Potential Loss / Potential Gain

Example

You're considering a trade:

• Entry price: $100
• Stop-loss: $95 (risking $5)
• Take-profit: $115 (targeting $15)

Risk-Reward Ratio = $5 : $15 = 1:3

This means for every $1 you risk, you're targeting $3 in profit.

Why Risk-Reward Matters More Than Win Rate

Most traders obsess over win rate—the percentage of trades they win. But win rate alone doesn't determine profitability.

The Math That Changes Everything

Consider two traders:

Trader A (High Win Rate, Bad R:R):

• Win rate: 70%
• Average win: $100
• Average loss: $300
• Over 10 trades: 7 wins ($700) - 3 losses ($900) = -$200 loss

Trader B (Low Win Rate, Good R:R):

• Win rate: 40%
• Average win: $300
• Average loss: $100
• Over 10 trades: 4 wins ($1,200) - 6 losses ($600) = +$600 profit

Trader B wins less often but makes more money because their wins are larger than their losses.

The Breakeven Win Rate Formula

Given any risk-reward ratio, you can calculate the minimum win rate needed to break even:

Breakeven Win Rate = 1 / (1 + Reward/Risk)

With a 1:3 risk-reward ratio, you only need to win 25% of your trades to break even. Win 40%, and you're very profitable.

How to Calculate Risk-Reward Before Every Trade

Step 1: Determine Your Entry Price

The price at which you'll enter the trade.

Step 2: Set Your Stop-Loss

Where will you exit if the trade goes against you? This should be:

• Based on technical levels (support, resistance, swing points)
• Not an arbitrary dollar amount
• Placed where your trade thesis is invalidated

The distance from entry to stop-loss is your risk.

Step 3: Set Your Take-Profit Target

Where will you exit if the trade works? This should be:

• Based on technical levels (resistance, Fibonacci extensions, previous highs)
• Realistic given recent price action
• Not just a wishful number

The distance from entry to take-profit is your reward.

Step 4: Calculate the Ratio

Risk = Entry Price - Stop-Loss (for longs)
Reward = Take-Profit - Entry Price (for longs)
R:R = Risk : Reward

Example Calculation

Long trade on XYZ stock:

• Entry: $50.00
• Stop-loss: $48.00 (Risk = $2.00)
• Take-profit: $56.00 (Reward = $6.00)
• R:R = $2 : $6 = 1:3

Question: Is this trade worth taking? Answer: With 1:3 R:R, you need only 25% win rate to break even. If your strategy wins 40% of the time, this is a great trade.

What's a "Good" Risk-Reward Ratio?

There's no universal answer, but here are common guidelines:

Minimum Standards

Many professional traders won't take trades unless the R:R is at least 1:2. This means:

• For every $1 risked, target at least $2 in profit
• Even with a 40% win rate, you'll be profitable

Don't Chase Unrealistic Ratios

A 1:10 ratio sounds great, but if your target is unrealistic, you'll rarely hit it. The best ratio is one that's:

• Achievable based on market conditions
• Based on real technical levels
• Consistent with your strategy's statistics

Risk-Reward in Practice

Scenario 1: Adjusting Position Size

You want to risk $100 per trade. How does R:R affect your approach?

With 1:2 R:R:

• Risk: $100
• Target: $200
• If you win 50% of 10 trades: +$500 profit

With 1:3 R:R:

• Risk: $100
• Target: $300
• If you win 40% of 10 trades: +$600 profit

Better R:R allows you to profit with fewer winning trades.

Scenario 2: Filtering Trade Setups

Before entering any trade, calculate the R:R. If it's below your minimum (say, 1:2), skip the trade—no matter how good it looks otherwise.

Trade idea:

• Entry: $25.00
• Logical stop-loss (below support): $24.00
• Nearest resistance (logical target): $26.50

Calculation:

• Risk: $1.00
• Reward: $1.50
• R:R = 1:1.5

If your minimum is 1:2, you'd skip this trade or wait for a better entry.

Scenario 3: Scaling Out

Some traders take partial profits to lock in gains:

Initial trade:

• Entry: $100
• Stop-loss: $95 (Risk = $5)
• Target 1: $110 (R:R = 1:2)
• Target 2: $115 (R:R = 1:3)

Execution:

• Sell 50% at $110, move stop to breakeven
• Let remaining 50% run to $115
• Worst case: breakeven. Best case: significant profit.

Common Risk-Reward Mistakes

1. Setting Stops Too Tight

Placing stops arbitrarily close to maximize R:R looks good on paper but leads to getting stopped out constantly.

Wrong approach: "I want 1:3 R:R, so I'll put my stop $1 away and target $3."

Right approach: Set stops at logical levels (support, below swing low), then see if the resulting R:R is acceptable.

2. Ignoring Win Rate

A 1:5 R:R sounds amazing, but if your strategy only wins 10% of the time, you're still losing money.

Balance is key: R:R and win rate must work together.

3. Moving Targets During Trades

Don't:

• Lower your take-profit because you're nervous
• Raise your take-profit because you're greedy
• Close early without a reason

Set your levels before entering and stick to them.

4. Not Tracking Your Actual R:R

Your planned R:R means nothing if you don't execute properly. Track:

• Planned R:R for each trade
• Actual R:R after closing
• Where you're deviating and why

5. Only Considering R:R, Not Probability

A 1:10 trade that only works 5% of the time is worse than a 1:2 trade that works 50% of the time.

Expected value matters:

Expected Value = (Win Rate × Average Win) - (Loss Rate × Average Loss)

The Expectancy Formula

Combine win rate and R:R to calculate your strategy's expectancy:

Expectancy = (Win Rate × Avg Win) - (Loss Rate × Avg Loss)

Example:

• Win rate: 45%
• Average win: $300
• Average loss: $100

Expectancy = (0.45 × $300) - (0.55 × $100)
Expectancy = $135 - $55 = $80 per trade

On average, you make $80 per trade. Over 100 trades, that's $8,000.

Building a Risk-Reward Focused Strategy

Pre-Trade Checklist

Before every trade, answer:

1. Where is my entry?
2. Where is my stop-loss (based on technicals)?
3. Where is my take-profit (based on technicals)?
4. What is the R:R?
5. Is it above my minimum threshold (e.g., 1:2)?
6. Given my strategy's win rate, is this trade worth taking?

Trade Journal Tracking

For every trade, record:

Over time, patterns emerge:

• Are you exiting too early?
• Are your targets realistic?
• What R:R do you actually achieve?

Key Takeaways

• Risk-reward ratio compares potential profit to potential loss
• A 1:2 or better R:R is a common minimum standard
• With good R:R, you can be profitable with less than 50% win rate
• Calculate R:R before every trade—not during
• Set stops and targets based on technical levels, not arbitrary numbers
• Track both planned and actual R:R in your trading journal
• R:R and win rate work together—neither alone determines profitability

Understanding risk-reward ratio transforms how you think about trading. It shifts focus from "being right" to "making money"—and those are surprisingly different goals.

Practice calculating and executing proper risk-reward ratios with ChartMini's trading simulator. Master the math of profitable trading before risking real capital.