Risk & Reward
Sizing the payoff against what you are risking to get it.
Overview
Risk-to-reward is the relationship between what you stand to lose if wrong and what you stand to gain if right. It is the single number that determines whether a strategy can survive being wrong often, which every strategy is.
How It Is Measured
Take the distance from entry to stop loss, and the distance from entry to target. The ratio between them is your risk-to-reward.
- Entry: 100
- Stop loss: 95 — you risk 5
- Target: 115 — you stand to gain 15
- Ratio: 3:1
Why It Matters More Than Win Rate
Traders fixate on how often they are right. The arithmetic says that matters less than how much they make when they are.
Over 10 trades, risking 1 unit each time:
- 90% win rate at 0.2:1 — 9 wins of 0.2 (+1.8), 1 loss of 1 (-1.0) = +0.8
- 40% win rate at 3:1 — 4 wins of 3 (+12.0), 6 losses of 1 (-6.0) = +6.0
The trader who is wrong most of the time makes considerably more. This is why chasing a high win rate by taking small profits and holding losers is so destructive: it inverts the ratio that actually generates returns.
Breakeven Requirements
Each ratio implies a minimum win rate just to avoid losing money, before fees.
- 1:1 — need above 50%
- 2:1 — need above 33%
- 3:1 — need above 25%
- 5:1 — need above 17%
Add trading fees and funding costs, and every one of those thresholds rises.
Setting Honest Targets
A ratio is only meaningful if the target is realistic. Placing a target far away purely to make the ratio look attractive produces a good-looking spreadsheet and a poor account.
Derive the target from the chart — the next level, the range boundary, the measured move — then calculate the ratio. Never work backwards from a ratio you would like to see.
If the resulting ratio is poor, the correct response is to skip the trade, not to move the stop closer.
Where Traders Undermine It
- Moving the stop further away to avoid being wrong
- Taking profit early because a position is green, cutting the ratio in half
- Choosing targets by hope rather than by structure
- Ignoring fees, which hit small-ratio trades hardest
Weaknesses & Limitations
- A calculated ratio assumes the stop and target are both reachable, which is not guaranteed
- Slippage in fast markets means the realised loss can exceed the planned one
- Very high ratios usually come with very low win rates, which is psychologically hard to sustain
- The ratio says nothing about probability
Example Use
A trader identifies support at 95 and resistance at 115, with price at 100. Entry 100, stop 94 below support, target 114 below resistance. Risk 6, reward 14, a ratio of roughly 2.3:1. It clears their 2:1 minimum, so the trade qualifies.
Risk Management Notes
Define your minimum acceptable ratio before you start looking at charts, and refuse trades below it. The rule only has value if it stops you taking trades you want to take, which is precisely when it is hardest to follow.