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Key Takeaways
- Planned risk is the distance from entry to logical invalidation, while planned reward is the distance from entry to the planned target.
- Reward divided by risk gives the R multiple: $2 of planned reward for $1 of planned risk is 2.0, or 2R.
- Pair the planned payoff ratio with win rate and realized average gains and losses.
- Calculate realized R from the complete net result divided by the original planned dollar risk.
- Use expectancy to combine outcome frequency and payoff size, then compare holding time and portfolio exposure.
What is the risk-reward ratio?
The risk-reward ratio measures a trade’s planned gain at its target price against its planned loss at the exit that invalidates it. Written as reward over risk, a $100 long entry, a $98 exit and a $104 target give $4 reward for $2 risk, or 2R. One R is the initial planned dollar loss on the whole position.
Write the order explicitly: 2-to-1 reward-to-risk is the same relationship as 1-to-2 risk-to-reward.
How to calculate the risk-reward ratio
For long stock, place the target above entry and the loss scenario below it. For short stock, the target is below entry and the loss scenario above it. Calculate positive gain and loss amounts from those correctly ordered prices.
The worked example buys 200 shares at $50. A $48.50 exit produces a $300 price loss; a $54.50 target produces a $900 price gain. The planned ratio is $900 ÷ $300 = 3 before costs.
Formula
Reward-to-risk ratio = planned target gain ÷ planned exit loss- For long stock with target > entry > exit: gain = target − entry and loss = entry − exit. For short stock with exit > entry > target: gain = entry − target and loss = exit − entry. Use a positive loss denominator.
- One R equals the initial planned dollar risk on the trade.
Worked Example
A trader plans to buy 200 shares at $50, exit if the thesis fails at $48.50, and take profit at $54.50.
- $50 − $48.50 = $1.50 planned risk per share
- $54.50 − $50 = $4.50 planned reward per share
- $4.50 / $1.50 = 3.0 reward-to-risk, or 3R
- $1.50 × 200 = $300 planned position risk before execution costs
At those prices, the 200-share position has $300 planned loss and $900 target gain before costs. The target is three times the initial risk, or 3R.
Realized R multiples and partial exits
Divide actual net profit or loss by the initial planned dollar risk. A $150 net gain on $100 initial risk is +1.5R; a $120 net loss is −1.2R.
Combine partial exits by original position weight. Half at +1R and half at +3R produce +2R before costs. Record changes to the exit plan while retaining the original denominator for the completed trade’s R result.
Risk-reward ratio, win rate and expectancy
A strategy winning 40% of trades at an average +2R and losing 60% at an average −1R has +0.2R gross expectancy per trade. Run the same math on outcomes after commissions and slippage to get the edge you actually keep.
Evaluate that average alongside holding time, drawdown and portfolio exposure. For a trailing exit, use the distribution of completed results to assess the payoff.
Risk-reward ratio for options trades
An underlying price distance is only one input to an option trade. Strike, expiration, premium and implied volatility determine the option’s modeled value before expiration. The Options Profit Calculator compares positions across your price, date and volatility scenarios.
Limitations of the risk-reward ratio
- Pair the ratio with a win rate. A 3R target with a low chance of being reached can still produce negative expectancy.
- Budget for the gap. A gap or slippage past the exit makes the realized loss larger than 1R, and a stop-market order fills at the market once triggered.
- Set the target from the chart, not from the ratio you want. Moving the target further away raises the ratio without making the trade more likely to work.
- Count the holding time. Two trades with the same ratio can tie up capital for very different periods.
- Price an options trade from the option’s own payoff. The underlying’s price distance does not convert one-for-one into option profit or loss, because premium, time and implied volatility also change the value.
Bottom line
The risk-reward ratio states, before entry, a trade’s planned gain relative to its planned risk. Use it with win rate and expectancy, measure results in R against the original planned risk, and judge option trades on their actual payoff rather than the underlying’s price distance.
Clear answers
Frequently Asked Questions
Sources and Further Reading
- Charles Schwab: 5 Elements of a Smart Trade Plan
- Fidelity: What You Need to Know About Exit Strategies
How entries are sourced, calculated and updated: editorial methodology.