Risk and Reward
The distance to a target divided by the distance to a stop. Useful for comparing opportunities, and meaningless without a realistic probability attached.
MadStockAlerts Research · Updated August 28, 2026
What to take away
- The risk-reward ratio compares the planned gain to the planned loss.
- A high ratio is worthless if the target is never reached.
- Required win rate falls as the ratio rises, and the arithmetic is exact.
- Targets set to flatter a ratio are the most common way it is misused.
- Both numbers should come from the chart, not from a preferred ratio.
MAD Academy Training Video · 0:46
The Number That Lets You Be Wrong
Reward-to-risk decides how often you can be wrong and still be profitable, which is why it is checked before the entry.
This lesson is part of a Stock Alerts + Tools plan.
The calculation
risk-reward = (target - entry) / (entry - stop)
- entry $40, stop $37, target $49 gives 9 divided by 3, or 3:1
What win rate it implies
break-even win rate = 1 / (1 + reward-to-risk)
| Ratio | Win rate needed to break even |
|---|---|
| 1:1 | 50% |
| 2:1 | 33% |
| 3:1 | 25% |
| 5:1 | 17% |
This is why a method can be wrong most of the time and still profitable. It is also why a method that wins seventy percent of the time can lose money if the losses are large enough relative to the wins.
The table is also the answer to the base rate problem in the patterns pillar. A pattern that works a quarter of the time is entirely usable at three-to-one and entirely unusable at one-to-one, and the pattern is the same in both cases.
The manipulation
The ratio is trivially improved by moving the target further away, and doing so does not improve the trade. A 10:1 ratio built on a target price has to be reached against odds nobody estimated. The ratio is only meaningful when both the stop and the target are levels the chart actually supports.
The same manipulation works from the other side. Tightening a stop to improve the ratio raises the probability of being stopped out by noise, and the improved ratio is bought with a worse win rate that the ratio does not show.
Scroll the chart sideways to see all of it.
Where the numbers come from
- Stops come from structure: a level below which the idea is no longer intact.
- Targets come from structure too: a prior high, a measured move, a level where supply appeared before.
- Neither should come from a preferred ratio, which is fitting the chart to the arithmetic.
- Both should be set before entry, when neither is a rationalisation.
A trade whose honest ratio is 1.2:1 is a trade with a 1.2:1 ratio. The correct response is to decide whether that is acceptable, not to move a line until the number reads better.
Why the planned ratio and the realised one differ
The ratio written down before a trade is a plan. The ratio that shows up in the record is a measurement, and across most records the measured one is worse. The gap is systematic rather than a matter of luck, and it comes from four places.
- Losses run past the planned exit, because gaps and fast markets fill below it while gains rarely overshoot in the same way.
- Winners are taken before the target, since holding for the last portion of a planned move is where the pull to realise a gain is strongest.
- Costs are subtracted from both ends and are proportionally larger relative to the smaller number.
- Trades that reached neither exit are closed somewhere in the middle, and there are usually more of these than of either clean outcome.
A plan built on a three-to-one ratio and executed at a realised one-and-a-half-to-one needs a much higher hit rate than the plan assumed. The method has not changed; only the number that was planned with was never the number that occurred.
This is the argument for computing the ratio from a record rather than from intentions. The realised figure is the one that belongs in any expectancy calculation, and it is the only one that has been tested against how exits are actually taken.
Where the target comes from
The exit that defines the risk side of the ratio is usually chosen from structure: a level below which the reason for the position no longer holds. The target on the reward side is chosen far more loosely, and that looseness is where most of the manipulation enters.
- A prior high or a prior area of heavy trading, which is a place where supply has previously appeared.
- A measured move projected from the size of the structure, which is a convention rather than a forecast.
- A multiple of the security's average daily range, which at least scales with how far it actually travels.
- Whatever number makes the ratio acceptable, which is the one that requires nothing of the chart and is the most common.
The first three have something in common: they are chosen by looking at the security rather than at the ratio. The test that separates them from the fourth is whether the target would be in the same place if the entry had been fifteen percent higher. A target derived from structure does not move; one derived from the ratio moves with the entry, which reveals that it was computed backwards.
A ratio is a claim about two unknown futures divided by each other. It is useful as a filter that rejects trades whose downside is large relative to any plausible upside, and it is not a measurement of anything until a record exists.