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
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.
Trailing Stop Strategies
Trailing stop strategies dynamically adjust your stop-loss level as a trade moves in your favour, locking in progressively more profit while still giving the trade room to develop. Unlike fixed stops, trailing stops adapt to market volatility and price action, allowing traders to capture the majority of a trend move without exiting prematurely on normal pullbacks.
Sharpe & Sortino Ratios
The Sharpe ratio measures risk-adjusted return by dividing excess return (above the risk-free rate) by the standard deviation of returns. The Sortino ratio improves on Sharpe by penalising only downside deviation, recognising that upside volatility is desirable. Both ratios help traders compare strategies on a level playing field and identify which approaches deliver the best returns for their level of risk.
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.