Definition
The risk-reward ratio compares how much a trade could lose if the stop-loss is hit with how much it could gain if the target is reached. A ratio of 1:3 means risking $1 for a potential $3.
How it works
For a long trade, risk = entry price − stop-loss price and reward = take-profit price − entry price. For a short trade the subtraction is reversed. The ratio is usually written as risk:reward, such as 1:2 or 1:3, but some traders write it the other way round as reward:risk, so it helps to check which order a figure uses.
The ratio links directly to how often a trade must win to break even. Break-even win rate = 1 ÷ (1 + reward ÷ risk). A trader needs to win 50% of trades at 1:1, about 33% at 1:2 and 25% at 1:3, before costs. Fees and slippage push these numbers slightly higher.
A ratio on its own says nothing about whether a trade is good. A distant target produces an attractive ratio on paper, but it may rarely be reached, so the real win rate falls. Moving a stop-loss closer to improve the ratio can let normal price swings trigger it. The ratio is useful only together with a realistic estimate of how likely each outcome is, and with position sizing, which decides how much money the risk represents.
Example (hypothetical numbers)
Suppose you plan to buy Token X at $100, with a stop-loss at $95 and a take-profit target at $115.
Risk = $100 − $95 = $5 per unit and reward = $115 − $100 = $15 per unit, so the ratio is 5:15, or 1:3.
Break-even win rate = 1 ÷ (1 + $15 ÷ $5) = 1 ÷ 4 = 25%.
Over 4 such trades with 1 win and 3 losses: 1 × $15 − 3 × $5 = $0 per unit before fees.
A 1:3 setup breaks even with 1 win in 4, but only if the target is actually reached that often.
Common mistakes
- Picking a far-off target just to make the ratio look good, without asking how often it is reached.
- Tightening the stop to improve the ratio until normal price noise triggers it.
- Mixing up risk:reward and reward:risk notation when comparing setups.
Related calculators
This glossary is for education only and is not investment advice. Examples use hypothetical numbers.