Before we enter a trade, it helps to put two numbers side by side: the loss we are planning for and the profit we are targeting. The risk/reward ratio compares those amounts. If our planned loss is ₹500 and our potential profit is ₹1,000, the risk:reward ratio is 1:2. We are risking one rupee for…
Before we enter a trade, it helps to put two numbers side by side: the loss we are planning for and the profit we are targeting. The risk/reward ratio compares those amounts.
If our planned loss is ₹500 and our potential profit is ₹1,000, the risk:reward ratio is 1:2. We are risking one rupee for a possible two-rupee gain. That tells us the size of the two outcomes, but not how likely either outcome is.
What Does the Risk/Reward Ratio Mean?
The risk/reward ratio measures planned downside against potential upside. For a trade with a defined entry, stop-loss and target, we calculate the loss at the stop and the profit at the target.
Throughout this guide, we write the ratio as risk:reward. A 1:3 ratio means one unit of planned risk for three units of potential reward.
Written as a division, the formula is:
Risk/reward ratio = Planned loss ÷ Potential profit
For ₹500 of risk and ₹1,000 of reward, the result is 0.5, or 1:2. The reverse calculation, reward divided by risk, gives 2. We need to check which convention a chart or calculator uses before comparing its numbers.
“Planned loss” matters here. A stop-loss is an exit instruction, not a promise that our loss cannot exceed a particular amount. A sharp price gap or poor liquidity can lead to a worse execution price.
How do We Calculate the Risk/Reward Ratio?
Let’s work through a hypothetical share purchase. All figures are illustrative and exclude charges and slippage, meaning the difference between the price we expect and the price we receive.
Our planned entry is ₹800, our stop-loss is ₹780, and our target is ₹860.
- Risk per share: ₹800 − ₹780 = ₹20.
- Potential reward per share: ₹860 − ₹800 = ₹60.
- Risk:reward: ₹20:₹60 = 1:3.
For 40 shares, the planned loss is ₹800 and the potential profit is ₹2,400. The purchase value is ₹32,000. That purchase value is different from the ₹800 loss calculated at our stop.
If we double the quantity to 80 shares, the ratio stays at 1:3. However, the planned loss rises to ₹1,600. A favourable-looking ratio can still involve more money than we intended to risk.
For a short trade, where we sell first and aim to buy back lower, the price differences reverse. Risk per unit is the stop price minus entry; reward per unit is entry minus target. The same risk:reward convention applies.
What is a Good Risk/Reward Ratio?
There is no single ratio that makes a trade worthwhile. We also need to consider how often the target is reached, how large actual losses are, and what trading costs remove from the result.
A 1:3 setup offers more potential reward per rupee of planned risk than a 1:1 setup. But a distant target may be reached less often. Moving our target further away changes the calculation without providing evidence that price will get there.
We can see the link with win rate through a simple break-even calculation:
Break-even win rate = Planned loss ÷ (Planned loss + Potential profit)
Before costs, a 1:1 ratio needs a 50% win rate to break even. At 1:2, that becomes about 33.3%; at 1:3, it becomes 25%.
These figures assume every winner earns the full target amount and every loser loses the planned amount, with equal rupee risk across trades. They describe the arithmetic, not the probability of success.
For example, across 12 hypothetical trades risking ₹800 each, three wins of ₹2,400 total ₹7,200. Nine losses of ₹800 also total ₹7,200. We break even before costs and lose money after costs. Winning one trade in four is therefore insufficient for a net profit under these assumptions.
How We Use the Eatio Ehen Planning a Trade
Start With Meaningful Price Levels
We first identify the entry, the point where the trade idea no longer holds, and a target supported by our analysis. The ratio follows from those levels.
In our ₹800 example, moving the stop from ₹780 to ₹790 halves the planned risk per share. With the same ₹860 target, the ratio becomes 1:6. But the stop is now closer to entry, so ordinary price movement may trigger it sooner. The improved number alone does not improve the trade idea.
Include Costs Before Comparing Setups
Costs reduce our winning outcome and add to our losing outcome. Suppose estimated round-trip charges are ₹80 in either outcome for the original 40-share example. This is an illustrative amount, not Nubra pricing.
The net target profit becomes ₹2,320, while the planned loss including charges becomes ₹880. Our ratio is then ₹880:₹2,320, or approximately 1:2.64, before any additional slippage.
Using those adjusted outcomes, the break-even win rate rises to 27.5%. A small change in costs can matter when we repeat a setup many times.
Match Quantity to the Planned Risk
Position size answers how much we trade. The risk/reward ratio answers how the planned loss compares with the target profit.
If we set an illustrative ₹600 loss budget and the stop is ₹20 from entry, the calculation gives 30 shares before costs. Allowing for charges would reduce the quantity that fits that budget. Execution risk can still push the realised loss beyond it.
Compare the Plan With Actual Results
After closing trades, we can record entry and exit prices, charges, and realised gains or losses. If we regularly exit before the target or lose more than planned, the original ratio will overstate what our approach achieves.
Looking at average wins and average losses alongside win rate gives us a clearer picture than reviewing target ratios alone. Past results still cannot guarantee future outcomes.
For options analysis, we can explore the option chain and strategy builder listed on Nubra. Alongside those tools, we still need to examine the position’s payoff and risks; a ratio alone cannot establish whether an options trade is suitable.
FAQs
What Does a 1:2 Risk/Reward Ratio Mean?
It means we plan to risk one unit for two units of potential profit. For example, a ₹300 planned loss and ₹600 target profit produce a 1:2 ratio before costs.
Is Risk/Reward the Same as Risk Per Trade?
No. Risk per trade is the rupee amount, or share of our trading capital, that we plan to lose if the exit is reached. Risk/reward compares that loss with the potential profit.
Can the Ratio Change After Entry?
Yes. Changing an exit level changes the remaining potential gain or loss. We can retain the original calculation in our records while separately reviewing the position from its current price.
Can We Lose Money With a 1:3 Ratio?
Yes. Too few winning trades, smaller realised profits, larger losses or costs can produce a loss overall. The ratio helps us evaluate a plan; it does not predict its result.
Disclaimer: The information provided in this blog is for educational and informational purposes only and should not be construed as investment advice, financial advice, or a recommendation to buy, sell, or hold any securities or financial products. Investments in the securities market are subject to market risks. Please read all related documents carefully before investing. Readers should conduct their own research and consult a SEBI-registered investment adviser or other qualified financial professional before making any investment decisions. Past performance is not indicative of future results.
