Risk–reward ratio explained with a hypothetical trade

Define the convention first

Here, risk:reward means planned loss : planned gain. Suppose a hypothetical entry is ₹100, a planned exit for a loss is ₹95 and a target is ₹110. The planned loss is ₹5 per share and the planned gain is ₹10 per share. That is 5:10, simplified to 1:2. Some tools display reward divided by risk instead, which would be 2. Always label the convention.

A planned exit is not a guaranteed price

The example assumes exact prices and excludes charges. Real execution may differ from an intended exit, including when prices move abruptly or liquidity is limited. Calculate what happens if the loss is larger or the gain smaller. Treat the ratio as a sketch of one scenario, not a ceiling on what you can lose in every situation.

Position size changes rupee exposure

In the simplified example, 10 shares have a planned price loss of ₹50 while 100 shares have a planned price loss of ₹500. Both have the same 1:2 ratio. The ratio alone therefore says nothing about whether the amount at risk is manageable for you. This arithmetic omits fees, slippage and other exposures and is not a suggested position size.

Probability still matters

Imagine ten separate paper trades with exact ₹5 losses and ₹10 gains per share. Three wins and seven losses produce ₹30 − ₹35 = −₹5 before costs. Four wins and six losses produce ₹40 − ₹30 = ₹10 before costs. The same planned ratio can accompany different outcomes. These invented sequences illustrate arithmetic; they are not evidence of an achievable win rate.

Write a better practice note

Record the entry assumption, invalidation reason, planned exit, target, quantity, cost assumptions and an adverse execution scenario. Explain why each price is there rather than adjusting a target just to produce a pleasing ratio. Review the result against the plan. If you cannot state the assumptions clearly, continue on paper instead of using the ratio as permission to trade.

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