The risk-reward ratio compares how much a trade can lose against how much it can realistically gain. A ratio of 1:2 means you are risking ₹1 to potentially make ₹2, and knowing this number before you enter tells you how often you need to be right just to break even.
How do I work out the ratio for a trade?
You need three prices, all decided before you enter:
- Entry. Where you buy (or sell).
- Stop-loss. Where you exit if you are wrong. Risk = entry − stop.
- Target. Where you plan to book profit if you are right. Reward = target − entry.
Anjali is looking at Sundar Textiles at ₹400. She decides that if it drops to ₹380 her idea has failed, and her target, based on her analysis, is ₹440.
- Risk = ₹400 − ₹380 = ₹20 per share
- Reward = ₹440 − ₹400 = ₹40 per share
- Risk-reward ratio = 20:40 = 1:2
If she trades 50 shares, she is risking ₹1,000 to potentially make ₹2,000. How she arrived at 50 shares is a separate decision. See what is position sizing?, and the exit at ₹380 works best as a real order, not a mental note: what are stop-loss orders and how to use them?.
Why does the ratio decide my breakeven win rate?
Here is the useful part. Once you know your ratio, simple arithmetic tells you what fraction of trades must win for you to break even (ignoring charges):
| Risk-reward ratio | Wins needed to break even |
|---|---|
| 1:1 | 50% |
| 1:1.5 | 40% |
| 1:2 | about 33% |
| 1:3 | 25% |
| 2:1 (risking 2 to make 1) | about 67% |
At 1:2, Anjali can be wrong on two trades out of three and still not lose money overall: two losses of ₹1,000 are paid for by one win of ₹2,000. At 2:1, the arithmetic flips. She must win two out of three just to stand still, which is a demanding hit rate to sustain.
So should I only take trades with huge ratios?
Here is the honest catch: win rate and risk-reward trade off against each other. A distant target is reached less often than a nearby one, so a 1:5 setup usually wins far less frequently than a 1:1 setup. Chasing a huge ratio by pushing your target further away, or shrinking risk by strangling the trade with an unrealistically tight stop, just moves the difficulty around. It doesn't remove it.
What the ratio really does is keep you honest. If a trade offers ₹5 of realistic upside against ₹20 of risk, the ratio makes that visible before you commit money, instead of after. Many traders simply skip setups where the reward doesn't meaningfully exceed the risk, and the ratio is the filter that catches them.
Remember also that charges nibble at the arithmetic. Brokerage, exchange fees and taxes mean your true breakeven win rate is slightly higher than the table shows.
Things to keep in mind
- Work out risk, reward and the ratio before entering; a ratio calculated after entry is just a rationalisation.
- The target must be realistic. A ratio built on a fantasy target is worse than no ratio at all.
- A good ratio does not make a trade more likely to win; it changes how many wins you need.
- No ratio guarantees profitability. It is a bookkeeping tool that keeps losses and gains in honest proportion.
Read next
Why do experienced traders always use a stop-loss? — The mechanism that enforces the loss you planned for.