The ratio between the potential loss (risk) and the potential gain (reward) on a single trade. Expressed as a ratio like 1:2 or 1:3, where 1:2 means you're risking $1 to potentially make $2.
Why It Matters
- 1Risk-reward ratio is fundamental to profitable trading, especially in prop firm environments where drawdown limits are strict.
- 2A trader with a 1:2 risk-reward ratio only needs to win 34% of their trades to break even.
- 3In prop trading, maintaining favorable risk-reward ratios helps you hit profit targets while staying well within drawdown limits.
- 4Most successful prop traders aim for at least 1:1.5, with many targeting 1:2 or higher.
Example
- 1You're trading ES futures on a $100,000 evaluation account.
- 2You enter long at 4,500 with a stop-loss at 4,495 (5 points risk = $250 per contract) and a take-profit at 4,510 (10 points reward = $500 per contract). Your risk-reward ratio is 1:2. Trading 2 contracts, you risk $500 to potentially make $1,000.
Common Mistakes
- ✖Chasing trades with poor risk-reward ratios just to increase win rate
- ✖Moving stop-losses further away mid-trade, which destroys the original risk-reward plan
- ✖Not accounting for commissions and slippage when calculating true risk-reward