The risk-reward ratio compares how much you stand to lose on a trade against how much you stand to gain. A 1:2 ratio means you risk one unit to make two. It sounds simple, but it is the single number that decides whether a trading edge survives contact with a funded account, because it sets the win rate you need to be profitable. Most traders obsess over being right. Risk-reward is what lets you be wrong more than half the time and still pass an evaluation.
Highlights of this article
- The risk-reward ratio compares the distance to your stop against the distance to your target
- A 1:2 ratio means risking 1 to make 2, and it only needs a 33% win rate to break even
- Win rate and risk-reward are linked: a higher reward ratio lowers the win rate you need
- On a funded account, risk-reward decides how fast you reach the profit target relative to the drawdown limit
- The most common way traders ruin their ratio is moving the stop and cutting the winner early
What is the risk-reward ratio?
The risk-reward ratio is the relationship between the potential loss and the potential profit on a single trade. It is written as risk to reward, so 1:2 means you are risking one unit of account value to make two.
The risk is the distance from your entry to your stop loss. The reward is the distance from your entry to your target. If you buy at $100, place a stop at $95, and target $110, you are risking $5 to make $10, a 1:2 ratio.
A ratio above 1:1 means the potential reward is larger than the potential risk. A ratio below 1:1, such as 2:1, means you are risking more than you stand to make, which forces a high win rate just to stay even. The ratio says nothing about whether a trade will win. It defines the payoff if it does, and that payoff is what a tested strategy compounds across hundreds of trades.
How to calculate the risk-reward ratio
Calculating it takes three numbers: the entry, the stop, and the target.
- Risk per unit = entry price minus stop price (for a long), in dollars or percent.
- Reward per unit = target price minus entry price.
- Ratio = risk to reward, simplified.
Worked example: you enter a long at $60,000, set a stop at $58,800 (a $1,200 risk), and a target at $63,600 (a $3,600 reward). The ratio is $1,200 to $3,600, which simplifies to 1:3. You are risking one to make three.
The ratio should be set before the trade, from the chart structure, not adjusted afterward to justify staying in. A target placed at a logical level and a stop placed at a logical invalidation give you the real ratio. A target moved closer because you are nervous gives you a worse one.
Risk-reward and win rate: the math that matters
Risk-reward only means something alongside win rate. Together they decide whether a strategy makes money. The table shows the win rate you need just to break even at each ratio.
| Risk-reward ratio | Breakeven win rate |
|---|---|
| 2:1 (risk more than you make) | 67% |
| 1:1 | 50% |
| 1:1.5 | 40% |
| 1:2 | 33% |
| 1:3 | 25% |
This is the most important table in trading. At 1:3, you can be wrong 75% of the time and still break even. At 2:1, you need to be right two out of every three trades just to avoid losing. A modest edge in win rate becomes highly profitable with a good ratio, and a strong win rate can still lose money with a bad one.
The practical takeaway is that chasing a high win rate with poor ratios is a trap. Many losing traders win often, taking small profits and letting losses run, which quietly produces a 2:1 or worse ratio that no win rate can save.
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Why risk-reward matters on a funded account
On a funded account, the risk-reward ratio decides how efficiently you move toward the profit target relative to your drawdown limit.
A challenge asks you to reach a profit target, often 8% to 10%, without breaching a maximum drawdown. With a good ratio, each winning trade covers several losing trades, so a normal win rate carries you to the target while keeping your losses small relative to the drawdown floor. With a poor ratio, every loss eats a disproportionate amount of your drawdown room, and a short losing streak can breach the account before the strategy has a chance to work.
This is why the traders who pass evaluations tend to focus on the ratio first and the win rate second. A 1:2 or better ratio means a 5 trade losing streak costs far less drawdown than the profit a few winners produce. It is the structural reason a tested edge survives the path to passing a challenge, and the reason a high-win-rate, poor-ratio approach so often fails one.
Common risk-reward mistakes
The ratio is easy to define and easy to ruin. A few mistakes destroy it in practice.
- Moving the stop. Widening a stop because price is approaching it turns a 1:2 trade into a 1:1 or worse, and removes the invalidation that defined the risk in the first place.
- Cutting winners early. Taking profit well before the target because the gain feels good shrinks the reward side and quietly inverts the ratio over many trades.
- Targets that are too far. A 1:5 ratio looks great on paper, but if the target is at an unrealistic level it rarely fills, and the real expectancy collapses. The ratio has to be achievable, not just large.
- Ignoring position size. A great ratio with an oversized position can still breach a daily loss limit on the losing trades. Size the position so the risk side fits your limit, then the ratio works as intended.
The traders who last set the stop and the target before entering, then let the trade resolve. The ratio only protects you if you respect both ends of it. A ratio you abandon the moment a trade goes against you was never a ratio at all, just a number you wrote down and ignored when it mattered.
Risk-reward in practice: a 10-trade example
The clearest way to see why risk-reward matters is to run a series of trades. Take a trader risking 1% of a funded account per trade at a 1:2 ratio, with a 40% win rate, over 10 trades.
- 4 winners at +2% each = +8%
- 6 losers at -1% each = -6%
- Net result = +2% across 10 trades
The trader was wrong on 6 of 10 trades and still finished ahead, because each winner was worth two losers. Now flip the ratio to 2:1 with the same 40% win rate:
- 4 winners at +1% each = +4%
- 6 losers at -2% each = -12%
- Net result = -8% across 10 trades
Same win rate, opposite outcome. The only thing that changed was the ratio. This is expectancy: the average result per trade, equal to the win rate times the average win minus the loss rate times the average loss. A positive expectancy is the definition of an edge, and risk-reward is half of the equation.
On a funded account the first sequence passes a challenge over time and the second breaches it, despite identical accuracy. Size each trade by its notional value so the 1% risk is real, set a ratio of 1:2 or better, and let expectancy do the work across many trades rather than depending on any single one. It is the same lesson behind why most traders fail prop challenges: the failure is rarely the strategy, it is the math of risking too much to make too little.
This article is educational and does not constitute financial advice. Trading leveraged products carries significant risk of loss.
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About the author
Vittorio De Angelis
Executive Chairman
Former equity-derivatives trader at JP Morgan, Dresdner Kleinwort and Bank of America in London. Later Head of Brokerage at a global broker in Hong Kong.
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