Risk-Reward Ratio: The Math Behind Every Winning Trade

Why Risk-Reward Ratio Trading Separates Winners From Losers

Watch a beginner trade and you'll see the pattern: they risk $500 on a scalp, hoping to make $150. They risk $1,000 on a swing, targeting a $200 gain. They're playing a game they've already lost mathematically.

Risk-reward ratio trading is the first principle that separates traders who last from traders who blow up. It's not about being right more often — it's about making more money on your winners than you lose on your losers.

Here's the brutal math: If you win 60% of your trades but risk $100 to make $50 each time, you're underwater. Over 100 trades, you'll win 60 times ($3,000) and lose 40 times ($4,000). You're -$1,000 despite a winning record.

Flip the numbers. Risk $50 to make $150 — a 1:3 ratio — and those same 60 wins generate $9,000 against $2,000 in losses. You're +$7,000. The only variable that changed: your risk-reward math.

Understanding the Risk-Reward Ratio Formula

The Basic Calculation

The risk-reward ratio is a simple division:

Risk-Reward Ratio = Profit Target ÷ Stop Loss Distance

Let's say you buy AAPL at $180 with a $2 stop loss (exit point if wrong) and a $6 profit target (exit point if right):

Ratio = $6 ÷ $2 = 1:3

You're risking $2 per share to make $6 per share. That's a 1:3 ratio — industry standard for a solid setup.

The Extended Formula: Position Sizing

Raw ratio numbers don't matter without position sizing. You need to know how many shares to buy so that your actual dollar risk stays consistent.

Here's the working formula:

Position Size = (Account Risk %) ÷ (Stop Loss Distance)

Example: You have a $10,000 trading account and risk 1% per trade ($100). Your stop loss on TSLA is $1.50 wide:

Position Size = $100 ÷ $1.50 = 66.67 shares ≈ 67 shares

If TSLA drops to your stop, you lose exactly $100. If it hits your profit target 3x further away ($4.50), you make exactly $300. That's a 1:3 ratio with consistent, managed risk.

Why Ratios Flip When Markets Move

Here's where beginners get trapped: You don't always get clean 1:3 setups.

Sometimes support is $0.75 away. Resistance is $1.50 away. That's a 1:2 ratio — worse odds mathematically, but maybe the only setup available.

The fix isn't to force a bad trade. It's to skip it. Or, if the setup has other edge factors (volume break, multiple time frame confirmation), you can accept 1:2 on high-conviction plays.

The key rule: Never take a trade with worse than 1:1 risk-reward on discretionary day trades. You're fighting math at that point.

Real-World Examples: Calculating Ratios in Live Markets

Example 1: AAPL Breakout (Feb 2024)

On February 13, 2024, AAPL was trading in a tight range at $184. A trader spots a breakout setup above $185.20 resistance:

• Entry: $185.30 (just above resistance)
• Stop Loss: $184.00 (below support) = $1.30 risk
• Profit Target: $188.90 (3x the risk distance) = $3.60 gain
• Risk-Reward Ratio: $3.60 ÷ $1.30 = 1:2.77 (clean 1:3)

Account size: $15,000. Risk per trade: 1% = $150.

Position Size = $150 ÷ $1.30 = 115 shares

If stopped out: 115 shares × $1.30 = $150 loss (exactly 1%).
If target hit: 115 shares × $3.60 = $414 gain (exactly 2.76%).

The math is clean. The risk is known before entry. This is executable.

Example 2: SPY Bounce Trade Gone Wrong (Mar 2024)

A trader sees SPY at $425 after a pullback and goes long without a real plan:

• Entry: $425.00 (just a guess)
• "Stop Loss": somewhere around $420 maybe? = $5.00 vague risk
• Target: $430 (just feels right) = $5.00 potential gain
• Risk-Reward Ratio: $5.00 ÷ $5.00 = 1:1 (worst-case scenario)

This trader needs a 55%+ win rate just to break even after commissions and slippage. On $10,000 account risking $500 at a time, they burn out in 20 trades.

The lesson: Vague setups produce vague risk-reward. Defined setups produce defined ratios.

Example 3: TSLA Scalp With Tight Stop (Apr 2024)

TSLA is in a tight intraday range. Volatility is low. A scalper enters:

• Entry: $245.50
• Stop Loss: $244.75 (tight, only 0.75 risk)
• Profit Target: $246.75 ($1.25 gain)
• Risk-Reward Ratio: $1.25 ÷ $0.75 = 1:1.67 (acceptable for scalps)

Position size on 1% account risk ($100): $100 ÷ $0.75 = 133 shares.

Scalps often have lower ratios (1:1.5 to 1:2) because you're trading higher frequency. The ratio compounds across multiple entries per day. A day trader taking 4 scalps at 1:1.67 with 60% accuracy is still building edge.

Position Sizing: The Missing Link Most Traders Ignore

Why Position Size Matters More Than Win Rate

Here's a table that will change how you think about trading:

This is the dark secret: A 70% win rate trader using 1:1 ratios loses money. A 40% win rate trader using 1:5 ratios prints cash.

Position size ensures that when your math works, your dollars work too.

The Position Sizing Formula in Action

Your account: $25,000. You risk $250 per trade (1%).

Setup 1 (tight stop):

• Stop loss distance: $0.50
• Position size = $250 ÷ $0.50 = 500 shares
• 500 shares × $0.50 stop = $250 risk ✓

Setup 2 (wide stop):

• Stop loss distance: $2.00
• Position size = $250 ÷ $2.00 = 125 shares
• 125 shares × $2.00 stop = $250 risk ✓

Same account, same risk per trade, different position sizes. The wider your stop, the fewer shares you buy. This scales automatically.

The Compounding Effect of Consistent Ratios

Let's run a 50-trade simulation with $10,000 starting capital, 1% risk, and 50% win rate:

With 1:2 ratio:

• 25 wins at 2% each = +$5,000
• 25 losses at 1% each = -$2,500
• Net: +$2,500 (25% gain)

With 1:1 ratio:

• 25 wins at 1% each = +$2,500
• 25 losses at 1% each = -$2,500
• Net: $0 (break-even, dead money)

One small ratio adjustment on 50 trades turned break-even into a $2,500 swing. Compound this over 200 trades a month and the difference is tens of thousands of dollars.

Setting Stops and Targets: The Mechanics Behind the Numbers

Stop Loss Placement: The Foundation

Your stop loss isn't emotional. It's technical. It marks the exact price where your thesis is wrong.

Common stop-loss methods:

• Below key support: If buying a breakout above $100, put stop at $98 (below the previous resistance-turned-support)
• Below moving average: Buy above 20-EMA, stop below it if price closes under
• Percentage-based: Risk 2% of entry price. Entry $200, stop at $196
• ATR-based (Advanced): Stop at entry minus 1.5x Average True Range

The method doesn't matter. Consistency does. Pick one, test it, stick with it for 50+ trades.

Profit Target Placement: Where Ratio Gets Real

Your profit target should be at a level that makes mathematical sense AND respects resistance.

Bad target: "I'll sell when I feel good" (emotional, breakable)

Good target: "I'll sell at the next resistance level IF it gives me at least 1:2 ratio" (mathematical, defensible)

Example: AAPL entry at $185, stop at $184, next resistance at $187.50.

$187.50 - $185 = $2.50 potential gain. $185 - $184 = $1 risk. Ratio: $2.50 ÷ $1 = 1:2.5. This works.

If the next resistance is only at $185.70, that's a $0.70 gain on $1 risk. That's 1:0.7 — worse than 1:1. Skip this trade.

Scaling Out: The Advanced Play

Once you're solid on single-target trades, scaling adds nuance.

Entry at $185, stop at $184:

• Sell 1/3 at $186 (1:1 ratio, lock profit)
• Sell 1/3 at $187 (1:2 ratio, secure gain)
• Let 1/3 run to $188.50 (1:3.5 ratio, seek windfall)

This approach reduces decision fatigue and lets winners run while protecting gains. It's more advanced — master single-target trades first.

Common Mistakes That Kill Your Risk-Reward Math

Mistake 1: Revenge Trading Without Recalculating

You take a loss. Frustrated, you immediately jump into the next setup without thinking.

You risk $1,000 on the loss trade (1.5% of account). You jump into the next trade and risk another $1,000. Now you're risking 3% total, the math is blown, and you're emotional.

Fix: After a loss, wait 5 minutes. Close the charts. Recalculate your risk size. Step back if you can't be objective.

Mistake 2: Moving Your Stop Loss After Entry

You enter TSLA at $250 with a stop at $248. Price drops to $249. You think "I'll move the stop to $249 to save $2."

You've now redefined your thesis. If price drops to $248.50, are you stopping there? No. You're hoping. Your stop is now a prayer.

Fix: Set your stop BEFORE entry. Never move it against your position (wider stops are okay; tighter stops betray doubt).

Mistake 3: Not Accounting for Slippage and Commissions

Your math says 1:3, but you're paying $15 round-trip commissions and slipping $0.25 on entry/exit.

Real entry cost: $180.25 + $15 ÷ shares slippage spread. Real profit: $190 - $0.25 slippage - $15 fees. You're now at roughly 1:2.7, not 1:3.

This seems small until you've done 100 trades. That's $1,500 in hidden costs.

Fix: Plan for slippage and commissions in your ratio target. If your math gives 1:2.8, target for 1:2.5 to account for friction.

Mistake 4: Using Wide Stops During High-Volatility Periods

VIX is at 25. Stocks are wild. You place a $3 stop on a $150 stock (2% risk). Your position size shrinks to 33 shares on a $10,000 account.

You can only make $100 on a win. You're swinging for home runs when you should be bunting.

Fix: When volatility rises, volatility-adjusted stop losses widen, position sizes shrink, and you take fewer trades. That's not weakness — that's survival.

Mistake 5: Confusing Best-Case Scenarios With Edge

You find a stock that went 1:5 three times last month. You think you've found a goldmine.

You don't know if those trades had good odds going in or got lucky after entry. You don't know if you can repeat them.

Fix: Test your strategy on 50 real trades minimum before assuming edge. One trade's ratio doesn't tell you if your method works.

Building Your Risk-Reward Trading Plan

Step 1: Define Your Account Risk Per Trade

Most day traders risk 1-2% per trade. Some aggressive traders risk 3%. Beginners should risk 0.5%.

$10,000 account at 1% = $100 risk per trade.
$50,000 account at 1% = $500 risk per trade.
$100,000 account at 1% = $1,000 risk per trade.

Lock this in. This becomes your anchor number for all position sizing.

Step 2: Define Your Minimum Acceptable Ratio

Write it down: "I will not take trades with worse than 1:2 risk-reward." Post it above your monitor.

This filters out 70% of your bad impulse trades automatically.

Step 3: Build a Setup Rule

Know exactly what qualifies as a trade for you:

• Breakout above 5-day high on volume? That's a setup.
• Failed breakdown bounce from 20-EMA? That's a setup.
• Stock just dropped 3% after earnings catalyst? That's a setup.

When you spot your setup, you immediately place your stop (defines risk) and calculate your target (defines reward). Entry comes only if the ratio works.

Step 4: Track Your Results

Spreadsheet or trading journal. Every trade gets:

• Entry price & time
• Exit price & time
• Risk amount (in dollars)
• Profit/Loss amount
• Intended ratio vs. actual ratio

After 50 trades, calculate: (Total Wins ÷ Total Trades) × Average Win Size - (Total Losses ÷ Total Trades) × Average Loss Size.

That's your expectancy. Positive? You have edge. Negative? Your setups need work.

Risk-Reward Ratio FAQ

Next Steps: From Theory to Execution

You now understand the math. The next move is application.

Tomorrow, before you take a single trade, write down your answers to these questions:

• What's my account size and my 1% risk amount?
• What's my minimum acceptable risk-reward ratio?
• What specific setups will I trade?
• Where do I place stops (technically, not emotionally)?
• How do I calculate position size from risk and stop distance?

Then, on your next 10 trades, manually calculate the ratio before entry. Say it out loud: "This trade is 1:2.5, risking $100 to make $250."

After 10 trades, review your execution. Did you stick to the ratio? Did you take sub-1:1 trades on emotional days? Did your actual results match your intended ratios?

This article is part of our comprehensive Day Trading guide. Once you've mastered risk-reward math, explore position sizing, entry triggers, and exit strategies to build a complete trading system.

The traders making consistent money aren't the ones with the highest win rates. They're the ones whose math works, whose positions are sized correctly, and who have the discipline to skip bad setups. That's the edge. That's the game.