Lessons › Risk and money management › Risk-to-reward ratio
World 5 · Risk and money management · lesson 4 · level 2
Risk-to-reward ratio
If you risk 1 to make 2, one win pays for two losses.
In one line
If you risk 1 to make 2, one win pays for two losses.
Explained simply
Imagine a game where a loss costs you 10 coins and a win pays you 20 coins. Win once and lose twice, and you are back where you started. That is a 1:2 risk-to-reward plan, where one win pays for two losses.
The lesson
Risk is the distance from entry to stop, and reward is the distance from entry to target. Risking 10 to make 20 is written 1:2, and because the reward is twice the risk it is also called a 2R target. A good ratio does not help if the target is unrealistic, so traders check it against the chart. Fees and spread shrink the real reward and grow the real risk, so the ratio after costs is what counts.
A worked example
Illustrative example: a trader plans to buy at 200 with a stop at 190 and a target at 220. The risk is 10 (200 minus 190) and the reward is 20 (220 minus 200), so the reward-to-risk is 2 (20 divided by 10), written 1:2 or a 2R target. Two losses of 1R and one win of 2R add up to 0 (2 minus 1 minus 1).
The same idea at four levels
- Beginner. Risk is what you lose if the stop is hit, and reward is what you make if the target is hit.
- Foundation. Risking 10 to make 20 is written 1:2, and the target is called 2R because it is twice the risk.
- Intermediate. With a 1:2 plan, one win pays for two losses, so you can be wrong more often than right and still break even.
- Advanced. Costs shrink the reward and grow the risk: risking 10 to make 20 with 2 of costs each way is really 12 to make 18, or 1.5R.
- Expert. Experts set the stop where the idea fails and the target where the chart allows, then trade only if the ratio still works, instead of stretching the target to fit.
Mistakes to avoid
- Stretching the target to an unrealistic level just to make the ratio look good.
- Forgetting fees and spread, which shrink the real reward.
- Squeezing the stop closer to entry to improve the ratio, so normal wiggles hit it.
Check yourself
What is the risk in a trade plan?
The distance from entry to stop. It is what you lose if the stop is hit.
What is the reward in a trade plan?
The distance from entry to target. It is what you make if the target is hit.
You risk 10 to make 20. How is that written?
1:2. Risk comes first, then reward.
What does a 2R target mean?
The reward is twice the risk. R is one unit of risk.
Entry 200, stop 190, target 220. What is the reward-to-risk ratio?
2. The reward of 20 divided by the risk of 10 is 2.
Goal of this lesson: Calculate the risk-to-reward ratio of a trade plan.