reward-to-risk
How much you aim to gain for each unit you risk; 3 to 1 means a target three times as far as the stop.
Reward-to-risk compares the planned gain with the amount at risk if the stop is hit. A ratio of 2:1 means the target gain is twice the planned loss.
The ratio describes a plan, not the chance of success. A distant target may be less likely to reach, and costs reduce the result. To judge a method, compare actual wins and losses across many trades after costs.
The ratio is often written as potential reward divided by risk. Keep the order clear when comparing plans.
Example
A made-up Northwind Foods trade has an entry at $40, a stop at $38, and a target at $44. The planned risk is $40 − $38 = $2 per share; the target gain is $44 − $40 = $4.
Reward-to-risk = $4 ÷ $2 = 2, or 2:1. With 10 shares, that is a planned $40 gain versus a $20 loss before costs. The ratio does not tell us whether the target or stop will be reached.
Common mistakes
- Reading the ratio as the probability of a winning trade.
- Comparing the target and stop distances in the wrong order.
- Ignoring costs or assuming the target will be reached.
- Most people who trade lose money.
Learn it in the course
- Win rate and reward-to-risk · A plan that wins three trades in ten can make money, and one that wins eight in ten can lose: see how the size of wins and losses decides, and find the break-even win rate.