Risk/reward ratio explained, with its limits

What it measures

The risk/reward ratio compares the distance to the point where an idea is wrong with the distance to where you plan to take the result. A ratio of 1:2 means the planned reward is twice the planned risk.

Ratio and win rate belong together

A high ratio alone says little. A strategy with a 1:3 ratio that rarely reaches its target can lose money, and a 1:1 strategy that works more often than not can make it. What matters is the combination of how often trades work and how large the results are when they do.

Expectancy = (win rate × average win) − (loss rate × average loss). Your journal gives you these figures from your own trades, not from someone else's claims.

The limits

Planned ratios are not results: prices can gap past a level, spreads widen around news, and exits are often earlier or later than planned. Track the ratio you planned and the ratio you got, side by side.