Definition
Risk-Reward Ratio
The risk-reward ratio compares the potential loss of a trade to its potential gain, guiding whether a setup is worth taking.
If you risk ₹10 (the distance to your stop loss) to make ₹30 (your target), the risk-reward ratio is 1:3, you stand to gain three times what you risk. Disciplined traders typically demand at least 1:2 or better before entering.
A favourable risk-reward means you can be wrong more often than right and still profit overall. Combined with a sensible position sizing and stop-loss discipline, it is the foundation of survival and consistency in trading.
Related terms
- Trailing Stop LossA trailing stop loss is a stop order that automatically moves up as the price rises, locking in profits while still protecting against reversals.
- Position SizingPosition sizing is deciding how much capital to allocate to a single trade or stock, to control risk across the portfolio.
- Stop LossA stop loss is a pre-set order that triggers an automatic sell (or buy, for shorts) once a security hits a chosen price, capping your loss without you having to watch the screen.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.