What Is Risk-Reward Ratio in Trading?
A short definition of risk-reward ratio, the formula for calculating it from a planned stop and target, a worked example, and how it differs from R-multiple and expectancy, which measure a trade after it closes rather than before entry.
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In short. The risk-reward ratio compares how much you stand to gain on a trade to how much you stand to lose, set before you enter. A trade with a $30 planned stop and a $90 planned target has a 1:3 risk-reward ratio: you are risking one dollar to make three. It is a planning number, based on where you place your stop and target, not a report on how the trade actually turned out.
What risk-reward ratio means
Risk-reward ratio, sometimes written reward-to-risk, measures the potential profit of a trade against the potential loss, both estimated before the position is opened. According to Babypips Forexpedia, it is a core risk management concept that helps traders judge whether a setup is worth taking given the level of risk involved.
The ratio itself needs two prices you decide in advance: a stop-loss, which sets your planned loss, and a target, which sets your planned gain. Neither has happened yet. That is the key difference from a metric like R-multiple, which measures what a trade actually returned once it closed.
How to calculate risk-reward ratio
The formula is straightforward:
Risk-reward ratio = Potential profit / Potential loss
Say you plan to buy at $100, place a stop-loss at $97, and set a target at $109. Your potential loss is $3 per share, and your potential profit is $9 per share. Divide $9 by $3 and the ratio is 3, usually written 1:3 or 3R planned. You are planning to risk one dollar to make three.
| Ratio | What it means | Example |
|---|---|---|
| 1:1 | Planned gain equals planned loss | $5 stop, $5 target |
| 1:2 | Planned gain is twice the planned loss | $5 stop, $10 target |
| 1:3 | Planned gain is three times the planned loss | $5 stop, $15 target |
| 2:1 | Planned loss is twice the planned gain (unfavorable) | $10 stop, $5 target |
Important. A favorable risk-reward ratio does not by itself mean a trade is profitable over time. A 1:3 setup that only hits its target 20% of the time can still lose money overall, while a 1:1 setup that wins 60% of the time can be solidly profitable. Ratio has to be read together with win rate, not on its own, a distinction covered in why your win rate lies without R-multiple.
Risk-reward ratio vs R-multiple vs expectancy
These three terms get mixed together often because they all involve a ratio to risk, but each answers a different question at a different point in the trade.
| Term | When you calculate it | What it measures |
|---|---|---|
| Risk-reward ratio | Before entering, from your planned stop and target | The setup's planned payoff, not what actually happened |
| R-multiple | After the trade closes | The actual result relative to the risk you took, see what is an R-multiple |
| Expectancy | Across many closed trades | The average R a strategy produces once win rate and average result are combined, see what is expectancy |
A trade planned at 1:3 risk-reward that gets closed early at half its target only realizes about +1.5R, not the +3R the setup implied. The planned ratio and the realized R-multiple are related but rarely identical, which is exactly why logging the actual exit matters as much as the plan.
Setting a minimum ratio before you trade
Most traders set a floor, such as never taking a setup below 1:1.5 or 1:2, so that a losing streak does not require an unrealistic win rate to recover from. That threshold should match the strategy's real win rate rather than being picked arbitrarily: a mean-reversion approach with a high win rate can work with a smaller ratio, while a trend-following approach with fewer, larger wins usually needs a higher one to stay profitable overall. Reviewing planned ratio against the strategy's performance metrics, including win rate and profit factor, over a meaningful sample of trades shows whether the minimum you picked actually holds up in practice, or whether targets are consistently missed before price reaches them.
This article is for educational purposes only and is not financial or investment advice. Risk-reward ratio is a planning tool, not a guarantee of outcome, and trading with leverage can result in losses that exceed the amount planned if a stop is not honored.
Log your planned stop, target, and actual exit on every trade, and see the realized R-multiple next to your plan in the BitStat trading journal.
Frequently asked questions
What is a good risk-reward ratio for trading?
Is a higher risk-reward ratio always better?
How is risk-reward ratio different from R-multiple?
Can risk-reward ratio guarantee a profitable trade?
How do you calculate risk-reward ratio for a trade?
Does risk-reward ratio account for position size?
Should every trade have the same risk-reward ratio?
BitStat Team
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