The ratio between the potential loss and potential gain on a trade.
The risk–reward ratio compares how much you stand to lose versus how much you stand to gain on a single trade. A 1:2 ratio means you risk $1 to potentially make $2. It is calculated by dividing the distance from entry to stop loss by the distance from entry to take profit.
A favorable risk–reward ratio means you don’t need to win most of your trades to be profitable. With a 1:3 ratio, you only need to win about 25% of trades to break even. It is one of the most important metrics for evaluating whether a trade is worth taking.
You enter a trade at $100 with a stop loss at $95 and a take profit at $110. Your risk is $5 and your reward is $10, giving you a 1:2 risk–reward ratio. Even if you lose half your trades with this ratio, you still come out ahead.
A 1:2 risk–reward ratio. The red zone shows the risk (1R) and the green zone shows the reward (2R). The reward is twice the risk.