How it is calculated
You need three prices: the entry, the stop loss, and the target you think the price could reach. The possible loss is the distance from entry to stop; the possible gain is the distance from entry to target. The ratio compares the two: R = possible gain ÷ possible loss. Written in risk : reward form, the loss comes first, so R = 3 is the same as 1 : 3.
The ratio and your win rate
Assuming every loss stops exactly at the stop (1R) and every winner reaches the full target, the ratio tells you how many trades out of 10 must win for you to break even overall. At 1 : 1 you break even at exactly half, and need more than half to come out ahead. At 1 : 3 you break even at a quarter, because one win covers 3 losses.
This is before costs, which push the required share up a little. The simple formula: break-even win rate = 1 ÷ (1 + R), where R is the possible gain divided by the possible loss. In practice, if you close winners before the target, or a gap takes a loss past the stop, the break-even point moves; once you have a trade record, use your actual average win and average loss.
Why the ratio alone is not enough
So the ratio measures the shape of a trade, not its chance of working. A trade with a good ratio and a weak reason can be worse than one with a lower ratio and a clearer reason.
Work it out on a stock you follow
Open a stock from your watchlist, set yourself an entry, a stop and a target, and work out the ratio before any decision.
Check yourself
1. Entry 50, stop 48, target 56. What is the ratio in risk : reward form?
2. At 1 : 1, where is the break-even win rate (before costs)?
Summary
- The ratio compares the distance to the target with the distance to the stop.
- The higher the ratio, the lower the win rate you need.
- A target is an estimate, not a promise, and the ratio does not measure the chance of success.