How do I use risk/reward ratios to evaluate potential stock trades?

Risk/reward ratio helps traders decide if a stock trade is worth it. It compares the **potential profit** of a trade to the **possible loss**. A good ratio is **1:2 or higher**, meaning for every ₹1 risked, the potential profit should be ₹2 or more.

1. What is the Risk/Reward Ratio?

The **risk/reward ratio** (R/R ratio) shows the relationship between the **potential loss** and **expected gain** in a trade. It helps traders make smart decisions by ensuring their profits outweigh their risks.

For example, if you risk **₹100** to earn **₹300**, the risk/reward ratio is **1:3**, which is a good trade.

2. How to Calculate the Risk/Reward Ratio?

You can calculate it using this formula:

Risk/Reward Ratio = Potential Loss / Potential Profit

For example, if you enter a stock trade at **₹500** with a stop-loss at **₹450** and a target price of **₹600**:

• Risk = ₹500 - ₹450 = ₹50
• Reward = ₹600 - ₹500 = ₹100
• Risk/Reward Ratio = 50/100 = **1:2**

This means for every **₹1 risked, you can earn ₹2**, making it a **good trade**.

3. What is a Good Risk/Reward Ratio?

A **1:2** ratio or higher is generally recommended. Here’s a guide:

• **1:1** – Risky trade, profit and loss are equal.
• **1:2** – Good trade, ₹1 risked for ₹2 profit.
• **1:3 or more** – Best trade, higher rewards than risk.

Always aim for a **higher reward than risk** to stay profitable in the long run.

4. How to Use Risk/Reward Ratio in Trading?

To use this ratio effectively:

• Set **stop-loss and target prices** before entering a trade.
• Only take trades where **reward is higher than risk**.
• Avoid trades with a **risk/reward ratio below 1:1**.
• Use **technical analysis** to predict price movements.
• Adjust your **trading strategy** based on market conditions.

5. Conclusion

The **risk/reward ratio** is a powerful tool that helps traders make profitable decisions. Always aim for a ratio of **1:2 or higher** to maximize profits while minimizing losses. By setting stop-loss and target prices, traders can control risks and increase success in stock trading.