What the risk-reward ratio measures
The risk-reward ratio compares what a trade stands to make if it reaches the target with what it loses if the stop is hit. Traders usually write it as 1 : 3 or 3R: risk one unit to make three.
risk = |entry − stop| · reward = |target − entry| · ratio = reward ÷ risk
On its own the ratio says nothing about whether a trade is good. A 1 : 5 trade that almost never reaches its target loses money, and a 1 : 1 trade that works two times in three makes plenty. The ratio only means something next to the win rate, which is why this calculator shows both.
The breakeven win rate
Every ratio implies a minimum win rate below which the strategy loses money over many trades, however good individual trades feel:
breakeven win rate = 1 ÷ (1 + ratio)
| Reward : risk | Breakeven win rate | In practice |
|---|---|---|
| 1 : 1 | 50.0% | You need to be right more often than not. |
| 1 : 1.5 | 40.0% | Four winners in ten covers the six losers. |
| 1 : 2 | 33.3% | One winner pays for two losers. |
| 1 : 2.5 | 28.6% | Roughly two winners in seven. |
| 1 : 3 | 25.0% | One winner in four breaks even. |
| 1 : 4 | 20.0% | One winner in five breaks even. |
These are breakeven figures before costs. To make money you need to beat them, and by more than it looks once spread and commission are included.
Why a higher ratio is not free
It is tempting to read that table and conclude that you should always aim for 1 : 4. The catch is that the same trade with a more distant target reaches it less often. Moving the target further away raises the ratio and lowers the win rate at the same time, and there is no guarantee the trade-off favours you.
The honest way to choose a target is the same as for a stop: put it where the market gives you a reason, such as the next resistance level, a measured move or a multiple of the instrument’s typical daily range, and then check the ratio. If the ratio is poor, skip the trade. Pushing the target out until the number looks good only changes the label on the same bet.
Costs change the ratio more than you expect
Spread and commission are paid on every trade, whichever way it goes. A round-trip cost makes every loss bigger and every win smaller, so it hits the ratio from both sides. The tighter your stop, the larger the share of the trade that costs consume.
Enter costs in price terms per unit: on a stock, the spread in dollars plus commission per share; on a currency pair, the spread in the pair’s price (1.2 pips on EUR/USD is 0.00012). The calculator adds the cost to the stop distance and takes it off the target distance.
A worked example
A long trade on a stock at $50.00, with the stop at $48.50 below a support level and the target at $54.50 at the next resistance. Round-trip costs are $0.10 a share.
- Risk before costs: $50.00 − $48.50 = $1.50; reward: $54.50 − $50.00 = $4.50. Ratio 1 : 3.00, breakeven win rate 25.0%.
- After costs: risk $1.50 + $0.10 = $1.60; reward $4.50 − $0.10 = $4.40. Ratio 1 : 2.75, breakeven win rate 26.7%.
- If this setup reaches its target 35% of the time, expectancy is 0.35 × 2.75 − 0.65 = +0.31R per trade.
- Risking $500 a trade, that averages +$156.25 per trade over a large number of trades. Individual trades are still either −$500 or +$1,375.
Ten cents a share sounds trivial, but it moved the breakeven win rate by almost two percentage points. On a scalping stop of $0.30, the same cost would be a third of the risk.
Expectancy and R-multiples
Expectancy combines the two numbers into the one that decides whether a strategy is worth trading:
expectancy (R) = win rate × ratio − (1 − win rate)
Measuring it in R, the amount risked on each trade, makes results comparable across instruments and account sizes. A trade that makes twice what it risked is +2R whether it was $40 on a small account or $4,000 on a large one. Positive expectancy is the requirement; the size of it, and how steady it is, decides how much you can safely risk per trade. Risk of ruin covers that step.
Use your own records for the win rate, not a hoped-for figure. A win rate from fewer than 30 to 50 trades is mostly noise, and one taken from trades where you moved the target is measuring a different strategy.
Planned R versus the R you actually get
The calculator shows the planned ratio. The realised one is usually lower, for predictable reasons:
- Early exits. Closing a winner before the target turns a planned 3R into 1.5R, which quietly changes the breakeven win rate.
- Slippage on stops. A stop that fills beyond its level makes the loss bigger than 1R.
- Moved stops. Widening a stop to avoid being taken out makes the loss bigger than planned and breaks the ratio entirely.
- Partial targets. Taking half off at 1R and running the rest gives an average R somewhere between the two, not the full target.
A journal that records the R of every closed trade is the only way to know which ratio you are really trading. Once the stop and target are set, the position size calculator turns the stop distance into the number of shares, lots or contracts that risks exactly the amount you chose.