The risk-reward ratio compares how much a trade could gain if it reaches its target with how much it could lose if it hits its stop. A trade risking $2 per share to make $6 has a reward-to-risk ratio of 3, often written 3:1 or 3R.
How it works
For a long trade, the calculation uses three prices fixed before entry:
- Risk = entry − stop. This is one unit of risk, called 1R; see stop-loss and position sizing.
- Reward = target − entry.
- Reward-to-risk ratio = reward ÷ risk. For a short trade, the signs reverse.
Conventions differ. Many traders say "risk-reward" but quote reward divided by risk, so a "3:1 trade" usually means the target is three times as far as the stop. Others write the same trade as 1:3. Check which way round a figure is meant before comparing.
The ratio only makes sense together with the probability of reaching the target. Ignoring costs, a trade breaks even over many repetitions when the win rate equals 1 ÷ (1 + ratio):
| Reward-to-risk | Break-even win rate |
|---|---|
| 0.5 | 66.7% |
| 1 | 50.0% |
| 2 | 33.3% |
| 3 | 25.0% |
The combined measure is expectancy: win rate × average win − loss rate × average loss, both in R. A positive expectancy, after costs, is what a trading method needs over many trades.
How to read it
- Targets and stops come from the chart, not the ratio. A stop belongs where the trade idea is wrong, such as below support or a multiple of ATR away; a target belongs below the next resistance. The ratio then tells you whether the trade is worth taking.
- Distance and probability move together. A more distant target is reached less often. Doubling the target does not double the expectancy.
- Style shapes the ratio. Trend-following systems often win fewer than 40% of trades and rely on a few large winners; short-term mean-reversion systems win more often with ratios below 1.
- Planned and realized ratios differ. Slippage, gaps and early exits mean the result in R rarely matches the plan exactly.
Worked example (illustrative numbers)
A trader buys at $50.00 with a stop at $48.00 below support and a target at $56.00 below resistance. Risk is $2.00, reward $6.00, so the ratio is 3 and the break-even win rate is 25%.
Suppose a method like this wins 30% of the time, every winner reaches the target and every loser hits the stop. Expectancy = 0.30 × 3R − 0.70 × 1R = +0.20R per trade. With $500 risked per trade, that is about $100 per trade on average over many trades, before costs, with long losing streaks along the way.
Now the trader moves the stop up to $49.50 to show a better ratio: risk $0.50, reward $6.50, ratio 13. On paper this looks far better, but a stop 1% below entry sits inside normal daily noise and is likely to be hit before the target. If the win rate falls to 5%, expectancy is 0.05 × 13R − 0.95 × 1R = −0.30R. The ratio improved; the trade got worse.
Limitations and common mistakes
- Fitting the levels to a ratio. Tightening the stop or stretching the target to reach "3:1" changes the probabilities, not the opportunity.
- Treating the ratio as the edge. Without a realistic win rate, a ratio says nothing about whether a trade makes money.
- Ignoring gaps. A stop limits the loss only while the stock trades through it; an overnight gap can produce a loss of 2R or more.
- Forgetting costs. Commissions, spreads and slippage reduce every winner and enlarge every loser, which matters most when the stop is tight.
- Moving the stop away. Widening a stop after entry raises the risk beyond the plan and makes the original ratio meaningless.
In Clear Tape
Every Clear Tape entry alert states its stop and target and shows the reward-to-risk ratio (R:R), calculated as (target − entry) ÷ (entry − stop); exit alerts show the result as an R multiple. Alerts appear on the Today page. The Clear Tape portfolio page shows the average R:R of open positions, measured from cost, and marks a position Protected once its stop is at or above cost. The Track record page reports average R, total R and a cumulative R chart. In trading systems, a target can be set as a multiple of R, and backtests report the win rate, average R and expectancy after costs. Trade alerts, positions and the track record are available to Pro members; watchlist screening and backtests to Tools and Pro members.
For educational purposes only. Not investment advice.