Risk–reward ratio is where discipline meets logic.
You do not need to predict markets perfectly to succeed.
You need to ensure that your potential gains are larger than your potential losses.
This lesson explains how risk–reward thinking allows even average accuracy to produce long-term success.
What Is Risk–Reward Ratio?
Risk–reward ratio compares:
How much you are willing to lose
versus
How much you aim to gain
It is expressed as:
- Risk : Reward
Example:
- Risk ₹1,000
- Potential reward ₹3,000
→ Risk–Reward = 1 : 3
📌 This means you risk 1 unit to make 3 units.
Why Risk–Reward Is More Important Than Win Rate
Many beginners believe:
- “I need to be right most of the time”
Professionals know:
- “I need my winners to be bigger than my losers”
Example:
- Win 4 trades, lose 6 trades
- Average loss: ₹1,000
- Average gain: ₹3,000
Result:
- Total loss = ₹6,000
- Total gain = ₹12,000
- Net profit = ₹6,000
📌 You can lose more often and still make money.
Simple Beginner Example
- Entry price: ₹200
- Stop loss: ₹190 → Risk = ₹10
- Target price: ₹230 → Reward = ₹30
Risk–Reward:
- 1 : 3
This trade can be wrong more than half the time and still remain profitable.
What Is a Good Risk–Reward Ratio?
General guidelines:
- 1 : 1 → Not attractive for beginners
- 1 : 2 → Minimum acceptable
- 1 : 3 or higher → Preferred
📌 Higher reward justifies taking the risk.
Risk–Reward Must Be Planned Before Entry
Risk–reward is not calculated after entering a trade.
You must define:
- Entry
- Stop loss
- Target
Before placing the trade.
📌 If risk–reward is poor, skip the trade — no matter how exciting it looks.
Common Risk–Reward Mistakes
❌ Taking trades with small reward and large risk
❌ Hoping price will move further without planning
❌ Ignoring risk–reward because of “strong feeling”
❌ Entering trades without defined exit levels
✔ Always calculate risk–reward first
✔ Skip trades with poor structure
✔ Be patient for quality setups
📌 Bad trades don’t fail — they were flawed from the start.
Investor vs Trader Perspective
Traders
- Apply risk–reward on each trade
- Use price targets and stop losses
- Focus on short-term probability
Investors
- Apply risk–reward at portfolio level
- Compare downside risk vs long-term upside
- Avoid asymmetric downside situations
Same principle, different time horizon.
Advanced Insight (For Intermediate & Experienced Readers)
Professionals evaluate:
- Expectancy = (Win rate × Average win) − (Loss rate × Average loss)
- Risk–reward directly improves expectancy
They ask:
“Does this setup have a positive mathematical edge?”
📌 Risk–reward turns uncertainty into probability.
Key Takeaways from Lesson 5
- Risk–reward defines long-term profitability
- You don’t need high accuracy
- Bigger winners offset smaller losses
- Planning exits is mandatory
- Discipline beats prediction
👉 Next Lesson: Emotional Risk – The Silent Killer
👈 Go Back to Risk Management Overview