Risk/Reward Ratio
Risk/reward ratio compares potential loss to potential gain on a trade. A 1:3 ratio means risking $1 to make $3. Higher ratios allow lower win rates while remaining profitable.
Definition
The risk/reward ratio (R:R) is the ratio between the money you'll lose if the trade hits your stop and the money you'll make if it hits your target. It's one of two variables — along with win rate — that determines long-term profitability. A 1:3 R:R means you need to win only 26% of the time to break even; a 1:1 R:R requires 51% to break even.
Formula
Risk/Reward = (Target Price − Entry Price) ÷ (Entry Price − Stop Loss Price)
Example
Buying at $100 with a stop at $95 and a target at $115: Risk = $5, Reward = $15. R:R = 1:3.