The Risk/Reward Ratio: How to Calculate It and When to Skip a Trade

Every risk/reward ratio has a break-even win rate, the share of trades you must win just to cover your losses, and it equals 1 ÷ (1 + the reward multiple) before costs.

Costs push it higher. In Sam's 100-trade simulation in Lesson 49: The Cost of Every Trade, costs averaged $3.78 a trade on $60 of risk (spread, slippage and the SEC's Section 31 fee on sales), about 6% of the risk on every trade, win or lose. That means a win pays a little less than planned and a loss costs a little more, so your real ratio is worse than the one you drew on the chart.

Calculated, not observed. With costs: win rate = (1 + cost) ÷ (1 + reward multiple), where cost is a fraction of the risk. The real ratio uses $3.78 of costs on $60 of risk: (reward minus $3.78) ÷ (risk plus $3.78).

A 1:0.8 trade asks you to win almost 6 out of 10 just to break even after costs. That's a high bar for anyone, and a very high one for a beginner. So why not just chase 1:3 or 1:5 every time?

No. In a market where price is equally likely to go up or down, a target is reached before the stop with a probability equal to the break-even win rate, so every ratio earns exactly zero before costs and loses the costs after them.

Here's the plain-English reason. If your stop is 50 cents away and your target is 75 cents away, the stop is closer, so a random wiggle reaches it first more often. The two distances balance out perfectly: the farther the target, the less often it's hit, and by exactly the amount the bigger payout makes up for.

DayTradingToolkit simulation: 40,000 random walks per row, each step one cent up or down with equal odds, stop 50 cents below the entry. The exact formula is stop distance ÷ (stop distance + target distance). Hypothetical, not market data.

Look at the first column and compare it with the break-even table above. They match. A random market hands you precisely the win rate you need before costs, and then costs take their small bite on every trade.

This is the most important thing to understand about the ratio: it tells you what a win pays, not how often you'll get paid. The ratio sets the bar. Your setup, your levels and your patience have to clear it. Lesson 56: Win Rate vs Risk/Reward shows how the two combine into expectancy.

This guide suggests a minimum of 1:1.5, measured to a realistic target, while you learn, and many traders prefer 1:2 for setups like breakouts and pullbacks.

At 1:1.5 you need to win roughly 43 trades in 100 after costs, which is a bar a well-chosen setup can reach without a heroic win rate. At 1:3 the bar drops to about 27%, but a target three times as far away has to be a real level, and real levels are often closer than that.

There's a catch worth knowing early. A bigger ratio isn't automatically better, because a distant target gets reached less often. A 1:5 trade that almost never hits its target can lose more than a 1:1.5 trade that often does. And skipping trades whose math needs a 59% win rate is one simple way to stop working against yourself.

Here's Sam's Wednesday check. Every price is hypothetical.

His stop belongs under $17.90, the low of the morning's pullback. His target can't honestly be above $18.80, where TUVW stalled twice last week. At 1:0.8, his break-even after costs would be about 59%. He skips it.

At 10:40, TUVW reached $18.78 and slid back to $18.10. The outcome doesn't prove anything; a skipped trade that would have won is just as possible. The decision came from the math, before the result.

On his card, under "Size from the math," Sam wrote: "Target from the chart. Below 1:1.5, no trade."

Sam now checks every trade three ways: stop, size and ratio. Each trade risks $60. But nothing on his card stops him from taking five of them in a bad morning and losing $300 before his shift. Where should the day end? Lesson 54: The Daily Max Loss Rule draws that line.