Risk-Reward Ratios
Overview
The risk-reward ratio (R:R or RRR) compares the potential loss (distance to stop loss) to the potential gain (distance to target) for each trade. A 1:2 R:R means you risk $1 to potentially make $2. By maintaining favourable risk-reward ratios, a trader can be profitable even with a win rate below 50%.
Key Concepts
R:R = Stop loss distance ÷ Take profit distance. 1:2 R:R with 40% win rate = profitable. 1:3 R:R with 30% win rate = profitable. Minimum R:R of 1:1.5 is recommended for most strategies. R-multiples: express all trades in terms of R (initial risk). A 3R winner = 3× your initial risk.
Entry Signals
Only take setups where the reward is at least 1.5× the risk. Define your stop loss first, then determine if the target provides adequate R:R. If the R:R is below your threshold, skip the trade regardless of the setup quality.
Exit Signals
Take partial profits at 1R, trail remainder for 2-3R. If a setup's R:R decreases (target gets hit by new resistance, or you need a wider stop), skip it. Reassess R:R if the trade approaches your target — does the remaining R:R justify holding?
Best Timeframes
Applies to every trade on every timeframe
Pro Tips
Risk-reward is not just about calculating R:R before entry. You must also consider the PROBABILITY of price reaching your target. A 1:10 R:R is worthless if the probability of reaching that target is 2%.
More Topics in This Category
Correlation-Aware Allocation
Correlation-aware allocation goes beyond simple diversification by mathematically measuring how assets move together and sizing positions accordingly. Two highly correlated positions (e.g., ES and NQ) effectively concentrate risk. By adjusting allocation based on measured correlations, traders build portfolios with better risk-adjusted returns.
Maximum Drawdown Limits
A maximum drawdown limit is a predefined loss threshold that triggers mandatory action — reducing size, stopping trading, or reviewing strategy. Common limits: daily max loss (e.g., 3%), weekly max loss (e.g., 5%), monthly max loss (e.g., 10%), and total max drawdown (e.g., 20%). Professional trading firms and prop firms enforce strict drawdown rules.
Fixed-Fractional Position Sizing
Fixed-fractional position sizing risks a fixed percentage of your account on every trade (commonly 1-2%). This ensures that a string of losses reduces position sizes proportionally, protecting capital during drawdowns. It's the most widely recommended position sizing method for discretionary traders because it's simple, sustainable, and mathematically sound.
Risk of Ruin Modeling
Risk of ruin calculates the probability that a trader will lose a specified percentage of their account — typically enough to end their trading career — given their win rate, average reward-to-risk ratio, and percentage risked per trade. This mathematical framework quantifies whether a trading strategy is survivable over the long run and helps traders set appropriate risk limits to ensure longevity.