Risk/reward (R:R) compares what you would lose if the stop is hit with what you would gain if price reaches the target. It describes trade structure; it does not guarantee profitability.
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How it is calculated
Calculate the distance from entry to stop and then from entry to target. If you risk 2 price units to pursue 4 units of reward, the ratio is 1:2.
R:R and win rate belong together
A strategy can be profitable with a relatively low win rate when average winners are sufficiently larger than average losers. Likewise, a high win rate does not necessarily compensate for losses that are much larger than gains.
Planned versus realised R:R
The planned ratio can differ from the realised one because of partial exits, break even, trailing, slippage or discretionary exits. Tracking both can show whether your management systematically improves or damages the initial profile.
Common mistakes
- Moving the target only to create a visually attractive R:R.
- Using a stop that is too tight for the actual setup structure.
- Comparing ratios without considering each strategy’s historical probability.
- Ignoring execution costs when expected margins are small.