Stop-Loss and the Risk/Reward Ratio
A stop-loss is a predefined level at which a losing position is closed automatically. Its job is not to "catch the reversal" but to cap the loss at a known amount. The risk/reward ratio (R/R) shows how many times larger the potential profit is than the risk.
Where to Place the Stop
The stop is placed by market structure — beyond a level, an extreme, or at a distance of several ATRs — and the position size is calculated from that distance. The beginner's mistake is the reverse: to pick a desired small loss and set the stop right next to the price, where ordinary market noise knocks it out.
| Risk/reward | Min. share of winners |
|---|---|
| 1 : 1 | 50% |
| 1 : 2 | ≈ 34% |
| 1 : 3 | 25% |
| 1 : 4 | 20% |
How R/R Relates to Win Rate
The higher the R/R, the smaller the share of winning trades you need in order not to lose. This is exact arithmetic: the minimum win rate to break even equals 1 / (1 + R/R). That is why a system cannot be judged by win rate alone — what matters is the combination of win rate and R/R over a sufficient sample.
- Beyond a level / an extreme
- Width from volatility (ATR)
- Size calculated from the stop
- Right next to price "for a small loss"
- Ignores market noise
- Knocked out before the move begins
In brief
- Trading without a stop means the market, not you, decides the size of the loss.
- The stop follows market structure; the size follows the distance to the stop.
- The minimum win rate to break even = 1 / (1 + R/R).
- Judge a system by the pairing of win rate and R/R, not by a single metric.