What is Risk-Reward Ratio?
The risk-reward ratio compares the potential loss of a trade to its potential profit, expressed as a ratio such as 1:2 meaning you risk $1 to potentially gain $2.
Risk-Reward Ratio Explained
Professional traders typically look for risk-reward ratios of at least 1:2 or better. This means even if you're right only 50% of the time, you can still be profitable. The risk-reward ratio is calculated before entering any trade and is a cornerstone of systematic trading discipline.
Real-World Example
You plan to buy a stock at $100 with a stop loss at $95 (risking $5) and a target at $115 (potential gain of $15). Your risk-reward ratio is 1:3 — you risk $5 to potentially gain $15.
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