Risk And Reward

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Planned risk is the loss implied by the intended entry and exit. Planned reward is the gain implied by the intended entry and target. Comparing them helps describe a trade, but does not show how likely either exit is.

Compare The Potential Gain With The Planned Loss

The reward-to-risk ratio compares the potential gain with the planned loss. An entry at $5.00, stop at $4.80 and target at $5.40 has $0.20 risk and $0.40 potential reward per share.

$0.40 ÷ $0.20 = 2, so the planned reward:risk is 2:1 before costs.

At 250 shares, the planned loss is $50.00 and target gain is $100.00. That means the potential gain is twice the planned loss. When reading a platform’s ratio, check which number refers to reward and which refers to risk.

What 1R Means

1R is one unit of the trade's initial planned price risk. In this example, 1R is $50.00. A $100.00 price gain is +2R; a $50.00 price loss is −1R.

If the actual loss is $62.50, it is −1.25R relative to the original $50.00. Keep the original $50.00 risk amount when comparing planned risk with actual results. For example, changing the original risk to $62.50 afterward would label that loss −1R instead of −1.25R, obscuring how much it exceeded the original plan.

Check Whether The Target Fits The Chart

In a different chart example, an entry at $5.00 and stop at $4.80 produce $0.20 of planned risk. A target at $5.60 makes the drawn potential reward $0.60, or 3:1. But earlier advances have repeatedly stalled near $5.20. The attractive ratio has not explained how the stock would get through that nearer resistance.

If the trader's setup takes profit at that nearer level, the proposed $5.20 exit offers $0.20, or 1:1 before costs. They can evaluate that trade using how the same approach has actually performed, wait for a different entry or pass. Moving the target past resistance solely to obtain 3:1 does not solve the problem.

There is no ratio in this example that automatically approves an entry. The target needs a reason, the exit needs a reason, and actual win frequency and completed results determine whether the approach has been profitable over the sample. The Win Rate And Expectancy lesson connects those results.

Compare Two Entry Prices

At the original $5.00 entry, the $5.40 target offers $0.40 per share against $0.20 of planned risk. If the actual entry rises to $5.10 while the stop and target remain unchanged, potential reward falls to $0.30 and planned risk rises to $0.30. The reward-to-risk ratio becomes 1:1.

The chart's target has not moved, but the entry changed the trade's proportions. Calculating the ratio from an intended entry after filling at a different price gives the wrong description. Recalculate from the relevant actual entry when reviewing a completed position.

Include The Effect Of Partial Exits

Suppose 250 shares fill at $5.00. The trader sells 125 at $5.20 and 125 at $5.40. The gains are $25.00 and $50.00, for $75.00 before costs. Relative to the original $50.00 planned price risk, that gain is +1.5R, not +2R.

The farthest exit reached the target, but only half the position sold there. Use the entire fill sequence rather than labeling the trade by its best exit. Costs reduce the net result further.

A ratio is useful for comparing the planned prices and describing actual results. It cannot replace a realistic target, appropriate size or evidence about how the approach has performed over comparable trades.

Compare The Target Gain With Actual Results

Planned reward:risk describes one proposed trade. Realized average win divided by realized average loss describes completed trades. These are different measurements.

To understand results across a sample, combine the sizes of actual wins and losses with how often each occurred. The Win Rate And Expectancy lesson works through that calculation. A large target alone is insufficient evidence that a trading approach has favorable results.