Risk-Reward Ratio

Risk-reward ratio is the comparison of what you can gain to what you can lose on a bet. If you risk $1 to make $3, the ratio is 1:3 (or 3:1 reward to risk). It doesn't tell you whether to take the bet — that depends on probability — but it frames the trade. A bet with a 1:3 reward-to-risk ratio only needs to win one time in four to break even; a 1:1 bet needs to win half the time. The ratio sets the bar: the better the ratio, the lower the win rate you need for the bet to be positive expectancy.

In practice, you define risk and reward explicitly. Risk is usually the distance from entry to your stop (or the max you're willing to lose). Reward is the distance to your target (or the gain you're aiming for). A trader might say "I'll risk 2% to make 6%" — a 1:3 ratio. The discipline is to not take bets where the potential reward is small relative to the risk unless the probability of winning is high enough to compensate. Many losing strategies are ones where the reward doesn't justify the risk: small upside, large downside, and win rate that doesn't fix the math.

The mental model extends beyond trading. Any decision where you put something at risk for a potential gain has a risk-reward structure. Hiring, launching a product, entering a market — you're risking time, capital, or reputation for a payoff. Making the ratio explicit forces you to state what you're risking and what you're aiming for, and to check whether the odds make the bet rational.