Risk-reward ratio (R:R) is a measure that compares the potential loss of a trade to its potential profit. It is expressed as a ratio such as 1:2 or 1:3, meaning you risk one unit to potentially gain two or three units. It is a foundational concept for evaluating whether a trade is worth taking.
The risk-reward ratio is calculated by dividing the distance between your entry and stop loss (risk) by the distance between your entry and take profit (reward). For example, if you enter at $100 with a stop loss at $95 and a take profit at $115, your risk is $5 and your reward is $15, giving you a 1:3 risk-reward ratio. To be profitable long-term, your risk-reward ratio and win rate must work together: a lower win rate requires a higher reward-to-risk ratio.
A trader enters EUR/USD at 1.1000 with a stop loss at 1.0950 (50 pips risk) and a take profit at 1.1150 (150 pips reward). The risk-reward ratio is 1:3. Even if this trader only wins 30% of their trades, they will be profitable because winning trades earn 3x what losing trades cost.
The risk-reward ratio determines whether a trading strategy is mathematically viable. Traders who ignore R:R often take trades where the potential loss exceeds the potential gain, which requires an unrealistically high win rate to be profitable. Combined with proper position sizing, a favorable R:R is one of the pillars of professional trading.