Trading glossary
Risk-reward ratio
By the PatternX team · Published
Definition
The risk-reward ratio compares what a trade could lose if its stop is hit with what it could gain if its target is reached. Written as reward:risk, a value of 2 means the target is twice as far from the entry as the stop.
Also called: reward:risk
How it's calculated
Reward:risk = |target − entry| ÷ |entry − stop|
Some traders write it the other way round, as risk:reward ("1:2"). The meaning is the same, so check which convention a tool uses before comparing numbers.
The ratio sets the share of trades a strategy must win just to break even, before costs:
Break-even win rate = 1 ÷ (1 + reward:risk)
| Reward:risk | Break-even win rate |
|---|---|
| 1 | 50% |
| 2 | 33.3% |
| 3 | 25% |
These figures are arithmetic, not predictions.
Why it matters
A high ratio doesn't make a trade good by itself, because distant targets are reached less often than near ones. The ratio only means something next to a realistic estimate of how often the target is hit. Costs work against it too: the spread and slippage shrink the reward and enlarge the risk on every trade.
Example
For example, a hypothetical long at $40.00 with a stop-loss at $38.50 (risk $1.50) and a target at $43.00 (reward $3.00) has a reward:risk of 2. If the entry fills at $40.10 and the stop later fills at $38.40, the real risk was $1.70 against $2.90 of remaining reward, a ratio of about 1.7.
Common mistakes
- Pushing the target further out to make the ratio look acceptable.
- Ignoring that a stop can fill beyond its level in a gap.
- Comparing numbers across tools that use opposite conventions.
How PatternX uses it
PatternX requires a reward:risk of at least 1 on its chart-pattern signals. When a pattern is detected, the stop is the tighter of your stop-loss setting and the pattern's stop, and the target is the nearer of your take-profit setting and the pattern's measured move; if the result is below 1, the setup is dropped. Elite users can require a higher minimum through the optional Elite risk filters. See risk controls.