Risk-Reward Ratio: What 1:1, 1:2 and 1:3 Mean

A risk-reward ratio compares how much you plan to lose if a trade fails with how much you aim to gain if it succeeds. Under the common risk-to-reward convention, 1:1 means risking one unit to target one unit, 1:2 means risking one unit to target two, and 1:3 means risking one unit to target three.

For example, if the planned loss is AED 100, the corresponding targets would be AED 100 at 1:1, AED 200 at 1:2 and AED 300 at 1:3. The same relationship applies whether risk is measured in rupees, dollars, pips, points or a percentage of account equity.

A higher ratio can reduce the win rate theoretically needed to break even, but it does not automatically make a trade better. The target must still be realistic given market structure, volatility, trading costs and the strategy’s historical behaviour.

What does risk-reward ratio mean?

The ratio is based on three planned prices:

• Entry: The price at which the position is opened.
• Stop loss: The price at which the original trade idea is considered invalid.
• Profit target: The price at which the planned gain is taken.

For a long position, the price distance from the entry down to the stop represents risk. The distance from the entry up to the target represents potential reward. For a short position, the directions are reversed: the stop is normally above the entry and the target is below it.

The basic calculation is:

Risk-reward ratio = distance to stop loss : distance to profit target

Some traders and platforms describe the relationship in the opposite order as a reward-to-risk ratio. A trade risking one unit to make three may therefore be called either 1:3 risk-reward or 3:1 reward-to-risk. Always check the convention being used. This article uses risk first and reward second.

What 1:1, 1:2 and 1:3 look like in a trade

Consider a purely hypothetical long forex trade with an entry at 1.1000 and a stop at 1.0950. The distance between the entry and stop is 50 pips, so 50 pips represents one unit of risk, commonly written as 1R.

• 1:1 target: A 50-pip target at 1.1050. The possible gain is equal to the planned risk.
• 1:2 target: A 100-pip target at 1.1100. The possible gain is twice the planned risk.
• 1:3 target: A 150-pip target at 1.1150. The possible gain is three times the planned risk.

If the trader planned to risk ₹1,000 on the position, a full stop would equal approximately minus 1R or ₹1,000 before costs. Reaching the three targets would produce approximately plus 1R, plus 2R or plus 3R respectively before spreads, commissions, taxes, financing charges and slippage.

The ratio depends on price distance, while the cash amount at risk also depends on position size. Increasing lot size does not improve the ratio: it increases both the potential loss and potential gain. If a wider stop is required, position size generally needs to be reduced to keep account risk unchanged.

Breakeven win rates for common ratios

Risk-reward ratio and win rate must be considered together. Ignoring trading costs, the theoretical breakeven win rate can be estimated with this formula:

Breakeven win rate = risk ÷ (risk + reward)

• 1:1 requires 50%: Five 1R wins and five 1R losses produce zero before costs.
• 1:2 requires about 33.3%: One 2R win offsets two 1R losses.
• 1:3 requires 25%: One 3R win offsets three 1R losses.

Actual breakeven rates are slightly higher because real trading includes costs. Results also differ if losses exceed the planned stop during a gap, targets are not filled at the expected price, or positions are closed early.

A low win rate is not automatically bad if average winners are much larger than average losers. Equally, a high win rate can still lead to losses if occasional losing trades are much larger than routine winners.

Use expectancy rather than judging one trade

No ratio can tell you whether an individual trade will win. Its value becomes clearer across a series of trades through expectancy, which combines the probability and size of wins and losses.

Expectancy = (win rate × average win) − (loss rate × average loss)

Suppose a hypothetical method wins 40% of its trades, its average winner is 2R, and its average loser is 1R. Its expectancy before costs would be:

(0.40 × 2R) − (0.60 × 1R) = 0.20R per trade.

This does not mean every trade earns 0.20R, nor does it guarantee future results. It is an average derived from assumptions or historical observations. A sequence can still contain several consecutive losses, and market conditions can change.

Expectancy should be calculated from actual completed trades or a carefully designed test. Using a target of 2R on a chart does not create a 2R average winner if most positions are manually closed at 0.5R.

How to choose a ratio for a trading plan

1. Define where the trade idea becomes invalid

Place the stop according to the trade logic rather than choosing an arbitrary monetary loss first. For example, a long trade may be invalid if price closes below a relevant support area, while a short trade may be invalid above a resistance level or recent swing high.

A very tight stop can create an attractive-looking ratio but may sit inside normal market noise. A distant stop may be technically sensible but require a much smaller position to keep risk controlled.

2. Identify a realistic target

Look for potential barriers between entry and target, including previous highs or lows, support and resistance zones, gaps and areas where momentum previously changed. Volatility also matters: expecting a market to move three times the stop distance may be unrealistic when the available trading range is limited.

Traders can use current context and research such as daily market analysis, but an analysis is not a substitute for their own entry, stop and exit rules.

3. Calculate the ratio before entering

If a long trade has an entry at 250, a stop at 245 and a target at 260, the risk is 5 points and the potential reward is 10 points. The ratio is therefore 1:2.

If resistance is located at 257, a 260 target may not be credible. Using 257 gives 7 points of potential reward against 5 points of risk, or 1:1.4. Ratios do not have to be whole numbers.

4. Set position size from the acceptable loss

Assume an account has AED 20,000 and the trading plan limits risk to 0.5% per trade. The maximum planned loss would be AED 100. Position size should then be calculated so that a move from entry to stop is approximately AED 100, subject to instrument specifications and possible slippage.

If the stop distance doubles while position size remains unchanged, the cash risk also roughly doubles. This is why a stop, position size and account-risk limit must be planned together.

5. Check whether the strategy can support the target

A 1:3 target sounds appealing, but it may be reached less often than a 1:1 target. The relevant question is not which ratio looks best in isolation. It is which combination of average win, average loss and win rate produces acceptable expectancy and drawdown for a defined method.

Gross ratio versus net trading result

A chart-based ratio usually measures price distances before trading expenses. Your final result can be different because of:

• Bid-ask spread at entry and exit
• Broker commission and applicable fees
• Overnight financing or swap charges
• Slippage in fast or illiquid markets
• Price gaps through a stop level
• Currency conversion and applicable taxes

Suppose a planned loss is 20 points and a target is 40 points. The displayed ratio is 1:2. If total entry and exit costs equal two points, the effective downside may be about 22 points while the net upside is about 38 points. The net relationship is therefore less favourable than 1:2.

Costs tend to have a greater proportional effect on strategies with small targets. They should be included when reviewing historical results and determining the minimum acceptable setup.

Partial exits and trailing stops change the realised ratio

A planned 1:3 trade does not necessarily produce 3R. If half the position is closed at 1R and the other half at 3R, the total result is 2R before costs: 0.5R from the first portion plus 1.5R from the second.

Moving a stop to the entry price can reduce the loss on some trades, but it may also cause positions to exit before the expected move develops. A trailing stop can produce wins larger or smaller than the original target. These are valid management choices when defined in advance, but they must be reflected in the strategy’s measured average win and loss.

Calling every losing trade minus 1R can also be misleading. A gap may create a loss larger than 1R, while an early exit may limit a loss to 0.4R. A trading journal should record the planned ratio and the realised R-multiple separately.

Risk-reward ratios in algorithmic trading

Algorithmic systems can apply predefined entry, stop and target rules consistently, but automation does not remove market risk. Finoways builds algorithmic trading software and research tools for FOREX, COMEX and US markets; its services do not involve holding client funds or guaranteeing results.

For an automated strategy, a fixed ratio should still be evaluated alongside fill quality, trading costs, win rate, drawdown and changing market conditions. A system that places a 1:3 target on every trade may perform poorly if its entry logic rarely captures moves of that size.

Common risk-reward mistakes

• Forcing every trade to meet 1:3: A distant target is not useful when market structure does not support it.
• Moving the stop farther away: This increases risk and changes the original ratio unless position size or target is adjusted.
• Ignoring costs: The gross ratio on a chart can overstate the net outcome.
• Confusing ratio with probability: A 1:3 setup does not have a higher chance of winning simply because the reward is larger.
• Changing exits emotionally: Taking small profits while allowing full losses can damage the realised ratio.
• Evaluating only a few trades: A short winning or losing sequence may not represent long-term expectancy.
• Risking more after a loss: Increasing size to recover losses can sharply raise drawdown and does not improve the trade setup.

A practical pre-trade checklist

1. Write down the entry, stop-loss and target prices.
2. Confirm why the stop represents invalidation of the setup.
3. Measure the stop and target distances using the same units.
4. Calculate the planned risk-reward ratio.
5. Check support, resistance, volatility and scheduled market events.
6. Set position size so a stop-out remains within the account-risk limit.
7. Estimate spread, commission and other relevant costs.
8. Define rules for partial exits, trailing stops and early closure.
9. Record both planned and realised R after the trade.

A risk-reward ratio is best treated as one part of a complete plan. A 1:1 setup can be viable with a sufficiently high net win rate, while 1:2 or 1:3 can work with lower win rates if targets are realistically achieved. What matters is consistent execution and positive expectancy after costs, not selecting the largest ratio visible on a chart.

Trading in leveraged and volatile markets carries a risk of loss, and stops may not always execute at the requested price. Review the risk disclosure before trading or using trading software.