The ratio comparing the potential loss (risk) to the potential gain (reward) on a trade, used to evaluate whether a trade is worth taking.
The risk-reward ratio compares the potential loss on a trade to the potential gain. It is one of the most fundamental concepts in trading discipline. A risk-reward ratio of 1:3 means INR 1 is at risk for INR 3 of potential gain - widely treated as a favourable setup.
To calculate risk-reward, three prices are required: entry, Stop Loss (defining maximum loss), and target (defining expected profit). A purchase at INR 500 with a stop loss at INR 480 and a target of INR 560 produces a risk of INR 20 and a reward of INR 60, giving a ratio of 1:3.
The mathematical significance is profound. At a 1:3 risk-reward ratio, a trader can be wrong on 70% of trades and still be profitable. Ten trades risking INR 1,000 each, with 7 losers (total loss INR 7,000) and 3 winners (total gain INR 9,000), produce a net profit of INR 2,000. This is why professional traders obsess over risk-reward rather than win rate.
In Indian market practice, swing traders commonly target setups with a minimum 1:2 risk-reward ratio. Intraday traders on NSE stocks may accept 1:1.5 because of higher win rates on shorter timeframes. The consistent discipline is applying the same risk-reward framework to every trade and not widening the stop loss to accommodate a losing position.
Risk-reward ratios are calculated before entry, not after. This requires clear identification of Support and Resistance levels, deliberate stop loss placement (not arbitrary), and profit targets grounded in chart structure. Many traders apply risk-reward as a final filter - even when all other conditions are met, an inadequate risk-reward causes the trade to be skipped.
Formula
Risk-Reward Ratio = (Entry Price - Stop Loss) / (Target Price - Entry Price)India Context
Most Indian trading educators recommend minimum 1:2 risk-reward for swing trades and 1:1.5 for intraday on NSE/BSE.