Risk/Reward Ratio Calculator

Understanding Risk/Reward Ratios in Stock Trading

The risk to reward ratio calculator (often abbreviated as R/R) measures the potential profit of a trade relative to its potential loss. The formula is:

Risk/Reward Ratio = Potential Reward ÷ Potential Risk

Where:
Potential Risk = |Entry Price - Stop Loss| × Position Size
Potential Reward = |Target Price - Entry Price| × Position Size

This ratio is a cornerstone of risk management, helping traders decide if a potential reward justifies the capital risked.

How to Determine Inputs

• • Entry Price: The price at which you intend to buy (for long trades) or sell short (for short trades) the stock.
• • Stop Loss Price: The predetermined price at which you will exit the trade to limit your loss if the stock moves against you. This is often set based on technical analysis, such as below a support level (for longs) or above a resistance level (for shorts).
• • Target Price: The price at which you plan to take profit if the trade moves in your favor. This might be based on resistance levels (for longs), support levels (for shorts), chart patterns, or a fixed R/R multiple (e.g., aiming for 2x your risk).
• • Position Size (Shares): The number of shares you intend to trade. This is crucial for calculating the total dollar amounts for potential profit and loss. Use our Position Size Calculator to determine this based on your account size and risk percentage per trade.

Interpreting Your Risk/Reward Ratio

The ratio is typically expressed as Risk:Reward. For example:

• • 1:1 Ratio: Potential loss equals potential profit.
• • 1:2 Ratio: Potential profit is twice the potential loss (Generally considered favorable).
• • 1:3 Ratio: Potential profit is three times the potential loss (Highly favorable).
• • 2:1 Ratio: Potential loss is twice the potential profit (Generally unfavorable - requires a very high win rate).

Many traders aim for setups offering at least a 1:2 or 1:3 risk/reward ratio, as this means winning trades significantly outweigh losing trades, allowing profitability even if fewer than half of the trades are winners.

Example Stock Trade Calculation

Imagine you want to buy Stock ABC:

• • Entry Price: $100
• • Stop Loss: $95 (Risk per share = $5)
• • Target Price: $115 (Reward per share = $15)
• • Position Size: 50 shares

Calculations:

Risk per Share = Entry Price - Stop Loss
Risk per Share = $100 - $95 = $5

Reward per Share = Target Price - Entry Price
Reward per Share = $115 - $100 = $15

Potential Loss = Risk per Share × Position Size
Potential Loss = $5 × 50 = $250

Potential Profit = Reward per Share × Position Size
Potential Profit = $15 × 50 = $750

Risk/Reward Ratio = Reward per Share ÷ Risk per Share
Risk/Reward Ratio = $15 ÷ $5 = 3 (or 1:3)

Win Rate Needed = 1 ÷ (1 + Risk/Reward Ratio)
Win Rate Needed = 1 ÷ (1 + 3) = 1 ÷ 4 = 0.25 = 25%

The ratio is 1:3, meaning you need to win only 25% of trades with this profile to break even.

Risk/Reward, Position Sizing, and Psychology

These two concepts work hand-in-hand. First, use the risk reward calculator to assess if a trade setup's potential reward justifies the risk per share. If the R/R is acceptable (e.g., 1:2 or better), then use the Position Size Calculator to determine how many shares to trade so that the *total dollar loss* (if the stop is hit) stays within your overall risk management plan (e.g., 1% of account capital). Sticking to trades with good R/R ratios and proper position sizing fosters discipline and reduces emotional trading.

For complete risk analysis, explore our other essential trading tools.