Risk Reward Ratio
The risk-reward ratio compares the potential profit of a trade to the potential loss. It tells traders how much they stand to gain for every rupee they risk. A trade with a 1:3 risk-reward ratio risks Rs 1 to potentially earn Rs 3. Understanding and maintaining a favourable risk-reward ratio is fundamental to long-term profitable trading.
What Is the Risk-Reward Ratio?
Risk-reward ratio = (Target Price – Entry Price) / (Entry Price – Stop Loss Price)
**Example:**
Entry: Rs 100
Stop-loss: Rs 95 (risk: Rs 5)
Target: Rs 115 (reward: Rs 15)
Risk-reward ratio: Rs 5 : Rs 15 = 1:3
Why Risk-Reward Ratio Matters
Imagine a trader with a 40% win rate but a 1:3 risk-reward on every trade:
– 10 trades: 4 winners, 6 losers
– Losses: 6 x Rs 1,000 = Rs 6,000
– Gains: 4 x Rs 3,000 = Rs 12,000
– Net profit: Rs 6,000
A trader with a 40% win rate and favourable risk-reward is profitable even though they lose more often than they win. This is the mathematical power of maintaining a good risk-reward ratio.
Minimum Recommended Risk-Reward
Most experienced traders recommend a minimum 1:2 risk-reward ratio:
– For every Rs 1 risked, aim for at least Rs 2 in profit
– This means you only need to be right 34% of the time to break even
Many successful traders use 1:3 or higher.
Risk-Reward and Win Rate Relationship
| Risk-Reward | Minimum Win Rate to Break Even |
|————-|——————————-|
| 1:1 | 50% |
| 1:2 | 33.3% |
| 1:3 | 25% |
| 1:5 | 16.7% |
Practical Example
Ramesh takes only trades where the risk-reward is at least 1:2. Over 50 trades, he wins 40% (20 winners, 30 losers). Risk per trade: Rs 2,000; Target profit per trade: Rs 4,000. Net result: 20 x Rs 4,000 – 30 x Rs 2,000 = Rs 80,000 – Rs 60,000 = Rs 20,000 profit. Despite losing more often than winning, his consistent risk-reward discipline creates a profitable outcome.
Key Takeaways
– Risk-reward ratio measures potential profit against potential loss in a trade
– A minimum 1:2 ratio means you only need to be right 33% of the time to be profitable
– Profitable trading does not require a high win rate if the risk-reward ratio is consistently favourable
– Calculate risk-reward before entering every trade; pass on trades with unfavourable ratios
– Combine risk-reward with position sizing for comprehensive risk management
