The risk-reward ratio expresses the potential profit of a trade relative to its potential loss. It is one of the most useful filters traders can apply before entering a position, because it forces an explicit comparison between what you stand to gain and what you stand to lose.
How do you calculate risk-reward before entering a trade?
Risk-reward is calculated by comparing the distance from your entry to your stop-loss (the risk) against the distance from your entry to your target (the reward).
If you buy at 100, place a stop at 95, and set a target at 115:
- Risk: 5 points (100 to 95)
- Reward: 15 points (100 to 115)
- Risk-reward ratio: 1:3
This means you are risking 1 unit to potentially gain 3. All three levels — entry, stop, and target — must be defined before you enter the trade. A risk-reward ratio calculated after entry, or adjusted mid-trade, is not serving its purpose as a pre-entry filter.
The practical calculation in pence or pounds: if your entry is at £2.50, your stop is at £2.30, and your target is at £2.90:
- Risk: £0.20 per share
- Reward: £0.40 per share
- Risk-reward ratio: 1:2
Why is a 1:2 minimum risk-reward commonly cited?
A 1:2 minimum is commonly cited because it means you only need to win one trade in three to break even (before transaction costs). If you risk £100 and target £200, two losing trades cost £200 and one winning trade recovers £200 — a breakeven result at a 33% win rate. Most active traders find it realistic to win more than 33% of their trades, which means a 1:2 minimum produces a positive expected value in practice.
Using a 1:1 ratio requires winning more than 50% of trades just to cover transaction costs, which is a much higher bar. Below that win rate, a 1:1 strategy is a slow drain on capital even if individual trades feel reasonable.
The 1:2 figure is a rule of thumb rather than a universal law. Some strategies — scalping, for instance — operate profitably at 1:1 or even below, because win rates are higher and transaction costs per trade are very small relative to account size. What matters is that the combination of your actual win rate and your average risk-reward produces a positive expected value. The 1:2 minimum is useful as a default because it provides meaningful buffer against normal win rate variation.
How do win rate and risk-reward interact? Worked calculation
Risk-reward ratio and win rate are not independent variables. They work together to produce a positive or negative expected value. Understanding the interaction prevents the common mistake of chasing high win rates at the expense of sensible reward targets.
The formula for expected value per trade is:
Expected value = (Win rate × Average win) − (Loss rate × Average loss)
Three examples illustrate the interaction clearly:
Strategy A: 1:1 risk-reward, 55% win rate.
EV = (0.55 × 1) − (0.45 × 1) = +0.10 per unit risked. This strategy is profitable.
Strategy B: 1:2 risk-reward, 40% win rate.
EV = (0.40 × 2) − (0.60 × 1) = +0.20 per unit risked. This strategy is more profitable than Strategy A, despite a lower win rate.
Strategy C: 1:3 risk-reward, 35% win rate.
EV = (0.35 × 3) − (0.65 × 1) = 1.05 − 0.65 = +0.40 per unit risked. This strategy is even more profitable, winning only slightly more than one trade in three.
The key insight: a trader with a 40% win rate and a 1:3 risk-reward ratio is not a “poor trader.” They are running a positive-expectancy strategy. A trader with a 60% win rate and a 1:0.5 ratio is losing money despite winning more often than not. Many traders focus obsessively on win rate while ignoring the reward side of the equation. Consistent profitability depends on the combination of both, expressed as expected value per trade.
How do you set realistic profit targets?
The reward side of a risk-reward ratio is only as good as the targets it is based on. A 1:5 ratio looks attractive on paper but is meaningless if the target is placed in empty air with no structural reason for price to stop there.
Realistic targets should be set at levels where a logical reason exists for price to pause or reverse:
- Prior swing highs or lows: Price that has previously reversed at a level is likely to encounter at least some resistance or support at that level again. The more times a level has been tested, the more significant it tends to be.
- Key round numbers: Round numbers such as 1.3000 on EUR/USD or £100 on an equity attract attention from many market participants and often act as short-term targets for profit-taking.
- Measured moves: Technical analysis patterns such as flags, channels, and head-and-shoulders formations have traditional measured move targets — price projections based on the size of the initial pattern. These are not guaranteed to be hit, but they provide a structured basis for target placement.
- ATR multiples: If the daily ATR for an instrument is 80 pips, a target at 2× ATR (160 pips) is asking price to travel two full average days of movement. That may be realistic for a multi-day swing trade but is unlikely to be achieved within a single session.
If you cannot explain in one sentence why price would stop at your target, it is probably positioned arbitrarily. Arbitrary targets undermine the entire exercise of calculating risk-reward because the reward figure has no credibility.
What is the most common mistake traders make with risk-reward?
The most damaging mistake is adjusting the stop after entry to “improve” the ratio. This typically happens in one of two ways:
Moving the stop closer to entry on a winning trade to make the ratio look better on paper. If a trade is moving in your favour, moving the stop to breakeven (entry price) is a common and sensible risk management technique. But moving it beyond breakeven — past the point where the original analysis placed it — in order to claim a better ratio on a trade that has already moved significantly is not improving the strategy; it is rewriting history.
Moving the stop further away on a losing trade to “give it more room” and preserve the ratio. If the price is approaching your stop, moving the stop further from entry increases risk rather than improving the ratio. A trader who starts with a 1:2 plan but keeps moving the stop away as price falls is not maintaining a 1:2 ratio — they are steadily increasing their risk while the position deteriorates.
The risk-reward ratio must be fixed at trade entry. Any post-entry adjustments to stop or target levels should be driven by changes in market structure or your trade thesis, not by a desire to make the numbers look better. Fear and greed are the usual drivers of this pattern.
How does risk-reward differ across trading strategies?
Different strategies require different risk-reward parameters because they operate on different timeframes and with different win rate expectations.
Scalping involves very short holding periods — seconds to minutes — and aims to capture small price movements. Scalpers often target 1:1 or even slightly below, accepting this because their win rates are typically 55–65% and their transaction costs per trade are very small relative to account size. The edge comes from the frequency and consistency of wins rather than from large individual reward-to-risk ratios.
Day trading typically targets 1:1.5 to 1:2.5. Holding periods are longer than scalping but all positions are closed by end of day. Win rates are often 45–55%. The combination of a reasonable win rate and a moderate risk-reward ratio produces positive expectancy without requiring extremely large moves relative to entry.
Swing trading holds positions for days to weeks and typically targets 1:2 to 1:4. Win rates are often 40–50%, which is acceptable because the larger reward multiple compensates for the lower win rate. Wider stops are required on these timeframes, but position sizing via the percentage risk model ensures the pound risk per trade remains constant regardless of the wider stop.
Trend following operates on the longest timeframes and accepts very low win rates — sometimes 25–35% — in exchange for occasional very large moves. A trend follower might run a 1:5 to 1:10 average risk-reward across their trade history, with the majority of trades small losers and a small number of large winners providing all the profit.
Why should you maintain a trade log to track actual vs planned risk-reward?
There is often a significant gap between the risk-reward ratios you plan at entry and the ratios you actually achieve in practice. A trader who plans 1:2 on every trade but consistently exits early — at 1:0.8 because they fear a reversal — is effectively running a 1:0.8 strategy, not a 1:2 strategy, even though their stated rules say 1:2.
A trade log that records both planned and actual entry, stop, and exit levels for every trade makes this visible. Over 20 or 30 trades, the average planned RR versus average achieved RR reveals whether your execution matches your rules. If your planned RR is 1:2 but your achieved RR averages 1:1.1, you have an execution problem that no amount of analysis or strategy refinement will fix without addressing the psychological drivers of the early exits.
The log should also track win rate separately. With both average achieved RR and win rate, you can calculate actual expected value per trade and compare it to what the strategy theoretically produces. This is the only reliable way to know whether your strategy is working as designed or whether execution errors are eroding its theoretical edge.
Related Reading
- Position sizing: how to calculate the right trade size for your account
- Stop-loss orders: where to place them and the trade-offs involved
- Trading psychology: how fear and greed affect decisions and what to do about it
- Leverage in trading: how it amplifies both gains and losses
- CFDs explained: how contracts for difference work and what makes them risky
Frequently asked questions
What risk-reward ratio should I aim for?
There is no universally correct answer — the right ratio depends on your strategy’s win rate. A 1:2 minimum is a sensible default for most active traders because it allows a win rate below 50% to still produce positive returns. If you are running a strategy with a documented win rate above 55%, a 1:1.5 minimum can work. If your win rate is below 45%, you need a higher minimum ratio — 1:2.5 or above — to stay in positive expectancy territory. Use the expected value formula to calculate the exact requirement for your specific win rate.
Can I have a 1:1 risk-reward and still be profitable?
Yes, but only if your win rate consistently exceeds 50% after accounting for transaction costs (spread, commission). At exactly 50% with 1:1 RR and zero transaction costs, you break even. In practice, transaction costs mean you need a win rate of 52–55% to produce a profit at 1:1. Some short-term strategies achieve this reliably; many do not. If you are trading at 1:1 and not consistently profitable, the first question to ask is whether your actual win rate (not your intuitive sense of it — from a trade log) is high enough to overcome costs.
How do I set take-profit levels?
Set take-profit levels at specific price points where a structural or technical reason exists for price to slow or reverse: prior swing highs (for long trades), key round numbers, established moving averages, or measured move targets derived from chart patterns. Avoid placing targets in the middle of open space with no prior price interaction. A target at £4.50 where price has previously reversed multiple times is a credible target; a target at £4.50 because it is £0.50 above entry is arbitrary. Credible targets make a 1:2 ratio meaningful; arbitrary targets make it theoretical noise.
Should I adjust my risk-reward ratio mid-trade?
Moving a stop to breakeven once a trade has moved a meaningful distance in your favour is a sensible risk management practice — it removes the possibility of a winner becoming a loser without removing all the potential profit. Adjusting targets mid-trade is more dangerous: exiting early because you are nervous about a reversal converts a planned 1:2 into an actual 1:0.8 and undermines the mathematical basis of your strategy. The test for any mid-trade adjustment is whether it is driven by new information (a structural level broken, unexpected news) or by fear. The former is analytical; the latter is not.
