Risk Reward Ratio: Why 1:3 Is Not Automatically Good

The relationship, precisely

Break-even win rate = 1 / (1 + R)        where R = reward / risk

   R = 0.5  ->  need 66.7% win rate
   R = 1.0  ->  need 50.0%
   R = 1.5  ->  need 40.0%
   R = 2.0  ->  need 33.3%
   R = 3.0  ->  need 25.0%
   R = 5.0  ->  need 16.7%

Expectancy = (Win% x R) - (Loss% x 1)

Example: R = 2.0 with a 40% win rate
   Expectancy = (0.40 x 2.0) - (0.60 x 1.0) = +0.20R per trade

Add costs of 0.05R per round trip:
   Net expectancy = +0.15R per trade

The break-even table is worth memorising. It converts any claimed setup into an immediately testable statement: if someone describes a strategy with a 1:3 ratio, the question is whether it wins more than a quarter of the time after costs. If it does not, the ratio is irrelevant.

The trade-off nobody mentions

Raising the profit target does not raise expectancy automatically, because fewer trades reach a more distant target. The relationship between target distance and hit rate is roughly what you would expect from a random walk: doubling the distance roughly halves the probability of reaching it before the stop.

Two observations. Expectancy peaks somewhere in the middle rather than rising indefinitely with the target. And the trailing exit outperforms every fixed target here, because it does not cap the occasional very large move. This pattern is typical of trend-based strategies and reversed for mean-reversion strategies, where distant targets are rarely reached.

Planned ratio versus realised ratio

The ratio you plan at entry is a hypothesis. The ratio that matters is the one your closed trades actually produced, and the gap between them is where most strategies leak.

• Slippage on stops. Realised losses are usually larger than planned, particularly in fast markets and on gaps.
• Early exits. Discretionary exits at 1.4R on a trade targeting 3R reduce the realised ratio without appearing in the plan.
• Partial fills. A scaled entry may not complete, changing the effective risk and the position’s ratio.
• Break-even stops. They convert would-be winners into scratches, lowering the average win while leaving average loss unchanged.
• Costs. A 0.05R round-trip cost turns a planned 2.0R into a realised 1.95R and a planned 1.0R loss into 1.05R.

Using the ratio sensibly

1. 1

   Never use it as a standalone filter without evidence

   Rejecting every trade below 1:2 is only useful if those trades genuinely had lower expectancy in your testing. Often they have a higher win rate that compensates.

2. 2

   Derive the target from structure, not from the ratio

   Setting a target at 3R because you want a 3:1 ratio places it at a price with no market significance. Set it where the move plausibly ends, then check whether the resulting ratio is acceptable.

3. 3

   Measure expectancy, not the ratio

   Expectancy in R per trade, multiplied by trades per year, is the number that determines returns. The ratio is one input to it.

4. 4

   Account for costs explicitly

   Express costs in R terms. A strategy with 0.1R costs and 0.15R expectancy is keeping only a third of its gross edge.

5. 5

   Compare exits rather than asserting a rule

   Backtest fixed targets and trailing exits on the same entries and let the results decide, rather than adopting a ratio because it is conventional.