# Risk-Reward Ratio Explained: How It Sets the Win Rate You Need

Source: https://cluenex.com/learn/portfolio-management/risk-reward-ratio/
Publisher: Cluenex (https://cluenex.com)
Updated: 2026-10-15

## Short answer

Risk-reward ratio is the potential gain divided by the potential loss on a trade. A 1:3 ratio (risk $1 to make $3) breaks even at a 25% win rate, while a 1:1 ratio needs 50%. Before costs, higher ratios lower the win rate you need.

## Key takeaways

- Risk-reward = (target price minus entry price) divided by (entry price minus stop price). Risking $5 a share to make $15 is 1:3.
- Break-even win rate = 1 divided by (1 + reward-to-risk). At 1:1 it is 50%, at 1:2 it is 33.3%, at 1:3 it is 25%.
- Expected value per trade = (win rate x average win) minus (loss rate x average loss). Positive means the setup pays off over many trades.
- The ratio is only as good as the target. A 1:3 plan with an unrealistic target is really a worse trade than it looks.
- No ratio, such as 1:3, is a universal rule. What matters is the ratio together with a win rate you have actually measured.

## What is the risk-reward ratio?

The risk-reward ratio compares how much you stand to gain on a trade with how much you stand to lose if it goes wrong. You work it out before you buy, using three prices: your entry, your stop, and your target.

A **stop** (stop-loss) is the price at which you commit to selling to limit a loss. A **target** is the price at which you plan to take profit.

**Formula:** Risk-reward = (Target price minus Entry price) divided by (Entry price minus Stop price)

This guide writes the ratio as risk to reward, so 1:3 means $1 of risk for $3 of possible reward.

## How do you calculate it? A worked example

Take an entry of $100, a stop of $95 and a target of $115. The risk is $5 a share and the reward is $15 a share, so the ratio is $15 divided by $5 = 3.0, or 1:3.

With 100 shares, you risk $500 to make $1,500. The ratio is the same whether you use dollars or percentages: a 5% loss against a 15% gain is also 1:3.

## What win rate do you need to break even?

The ratio sets the minimum win rate you need. The formula is: break-even win rate = 1 divided by (1 + reward-to-risk).

| Risk:Reward | Break-even win rate | Meaning |
|---|---|---|
| 1:0.5 | 66.7% | Need to win 2 of every 3 trades |
| 1:1 | 50.0% | Need to win 1 of every 2 |
| 1:1.5 | 40.0% | Need to win 2 of every 5 |
| 1:2 | 33.3% | Need to win 1 of every 3 |
| 1:3 | 25.0% | Need to win 1 of every 4 |
| 1:4 | 20.0% | Need to win 1 of every 5 |

This is the break-even point before commissions, spreads and taxes. Real results need a win rate somewhat above these numbers.

## How do win rate and ratio combine? Expected value

Expected value (EV) is the average result per trade if you could repeat the same setup many times. EV = (win rate x average win) minus (loss rate x average loss).

Per $100 risked:

| Win rate | Risk:Reward | Calculation | EV per trade |
|---|---|---|---|
| 50% | 1:1 | (0.50 x 100) minus (0.50 x 100) | $0 |
| 40% | 1:1 | (0.40 x 100) minus (0.60 x 100) | minus $20 |
| 40% | 1:2 | (0.40 x 200) minus (0.60 x 100) | +$20 |
| 40% | 1:3 | (0.40 x 300) minus (0.60 x 100) | +$60 |
| 30% | 1:4 | (0.30 x 400) minus (0.70 x 100) | +$50 |
| 70% | 1:0.5 | (0.70 x 50) minus (0.30 x 100) | +$5 |

A high win rate does not rescue a poor ratio. A trader who wins 70% of the time but makes only $50 on each win and loses $100 on each loss earns just $5 per trade, and a modest dip in win rate erases it.

## Why does the target matter more than the ratio?

A ratio is only as believable as the target behind it. Anyone can make a trade look like 1:5 by naming a distant target.

Common, reasonable anchors for a target include:

- A prior high or the next level where the price has stalled before.
- A multiple of the stock's typical daily range, such as 3 times its average true range (ATR, the average distance a stock moves in a day).
- A fair value estimate from a valuation model, if you have one you trust.

The question to ask is not "what ratio can I get?" but "how likely is the price to reach this target before it hits my stop?" That probability is your win rate for the trade, and it is the hardest part to estimate.

## Does it work for long-term investing?

Yes, in a looser form. For a long-term holding, reward is the gap between price and your estimate of what the business is worth, and risk is how far the price could fall if you are wrong.

Example: you estimate a stock is worth $200, it trades at $120, and you would accept a fall to $100. Reward is $80, risk is $20, so the ratio is 1:4. The estimate of $200 is a judgment, not a fact, so test it with a more cautious case too. If the cautious value is $140, the ratio falls to 1:1.

Cluenex shows fair value with three cases (cautious, base, optimistic), which makes it easy to run the ratio against each. See [how Cluenex values stocks](https://cluenex.com/guides/how-we-value/).

## Where does the risk-reward ratio fail?

The ratio is a planning tool, not a prediction. These are the main ways it misleads:

- **Gaps.** If a stock opens far below your stop after bad news, you lose more than planned, so real risk is bigger than the ratio says.
- **Costs.** Commissions, bid-ask spreads and taxes shrink wins and enlarge losses, which hurts tight, low-ratio trades most.
- **Invented win rates.** The tables above only work with a win rate you have measured over many trades. Guessing 55% makes the EV math meaningless.
- **Moving the stop.** If you widen the stop after entering, the real ratio gets worse than the one you planned.
- **Cutting winners early.** Selling at $107 instead of the $115 target in the example above turns a 1:3 plan into roughly 1:1.4, which needs about a 42% win rate to break even.
- **Small samples.** A 25% win rate means long losing streaks are normal. Ten trades say little about whether an edge exists.

A high ratio also does not mean a good trade. A 1:10 setup with a 3% chance of success has an EV below zero: (0.03 x 1,000) minus (0.97 x 100) = minus $67.

## Is 1:3 really the right baseline?

No single ratio is right for everyone. 1:3 is popular because it lets you be wrong most of the time and still break even, but a strategy with a measured 65% win rate can do well at 1:1.5, and a trend-following style with a 30% win rate may need 1:4 or more. Match the ratio to evidence about your own results, not to a rule of thumb.

## What this means for you

If you have a regular job and a brokerage account, the ratio is most useful as a pre-trade check. A few habits help:

1. Write down the entry, stop and target before you place an order.
2. Compute the ratio and the break-even win rate from the table above.
3. Ask honestly whether the target has a reason behind it, not just a hope.
4. Keep a simple log of results so you learn your real win rate instead of guessing it.
5. Pair it with position sizing so a single loss stays small. See [what position sizing is](/learn/portfolio-management/position-sizing/) and [how to set stop losses](/learn/portfolio-management/stop-loss-methods/).

For longer-term holdings, test the ratio against a cautious case, and consider [when to cut losses versus hold](/learn/portfolio-management/cut-losses-vs-hold/).

## Questions people ask

### What is a good risk-reward ratio?

There is no universal number, but many traders look for at least 1:2, which breaks even at a 33.3% win rate. The right ratio depends on your measured win rate: the lower it is, the higher the ratio you need.

### How do you calculate risk-reward ratio?

Divide the potential gain by the potential loss: (target minus entry) divided by (entry minus stop). With entry $100, stop $95 and target $115, that is $15 divided by $5, or 1:3.

### Is a 1:3 risk-reward ratio profitable at a 40% win rate?

Yes, before costs. Per $100 risked, the expected result is (0.40 x $300) minus (0.60 x $100) = +$60 per trade on average. That only holds if the 40% win rate is real and the targets are actually reached.

### Does risk-reward ratio replace position sizing?

No. The ratio tells you whether a trade is worth taking, while position sizing decides how many dollars you put at risk on it. You need both.

### Can a high win rate make up for a low risk-reward ratio?

Only partly. A 70% win rate at 1:0.5 yields just +$5 per $100 risked, and a small drop in win rate wipes it out. A better ratio gives you a bigger cushion.

## Sources

- [Investor Bulletin: Stop-Loss Orders](https://www.investor.gov/introduction-investing/investing-basics/glossary/stop-loss-order)
- [Expected value](https://en.wikipedia.org/wiki/Expected_value)

Cite as: Cluenex. "Risk-Reward Ratio Explained: How It Sets the Win Rate You Need." Cluenex Learn, updated Oct 15, 2026. https://cluenex.com/learn/portfolio-management/risk-reward-ratio/