The risk-reward ratio compares what a trade can make with what it can lose. A trade risking $100 to make $300 has a risk-reward of 1:3; most journals and traders simply write 3 or 3R.
Formula
R:R = |target − entry| / |entry − stop|
Example
Short gold at 2,400 with a stop at 2,410 and a target at 2,370: 30 points of reward against 10 of risk. R:R is 3.0.
Why a higher R:R is not automatically better
A distant target is reached less often. What matters is the combination of R:R and the probability of reaching the target:
A 1:5 setup that wins 12% of the time loses money; a 1:1 setup that wins 58% of the time makes it. The win rate and the R:R have to be read together, which is what expectancy does.
Planned versus realized
- Planned R:R is set at entry from the stop and the take profit.
- Realized R:R is what happened: the average win divided by the average loss, also called the payoff ratio.
If the planned R:R is 2.5 and the realized one is 1.3, exits are not following the plan. Sort the trades by planned R:R and look at the R they actually produced.
In SetupBook
The trade form computes the planned R:R from entry, stop and take profit, and the trades table shows it in its own column next to the realized R. Analytics shows the realized side as average win, average loss and payoff.