Setting risk-reward ratios in a written trading plan
Risk-reward ratio is the distance to your target divided by the distance to your stop. Traders mention R:R constantly but rarely write it into their plan with enough specificity to filter bad trades before entry.
Why R:R belongs in the document
A plan without a minimum R:R threshold allows you to take structurally poor trades because the entry signal fired. Writing "minimum 1.5:1 reward to risk before entry" forces you to measure target and stop at the moment of decision — not after the trade is open and hope has replaced arithmetic.
Deriving your minimum from history
Mark thirty historical examples of your setup over the past year. For each, record where a structural stop would have sat and where the next logical target level was. Calculate R:R for winners and losers separately. Your minimum threshold should sit below the median R:R of winning examples — otherwise you will reject most valid trades.
A swing trader on daily FTSE charts might find winners average 2.1:1 while losers average 0.8:1 when stops were placed correctly. A plan minimum of 1.5:1 filters the worst entries without being unreachable.
Writing the sizing section alongside R:R
R:R and position sizing are linked. Your plan should show the calculation:
- Account equity: £10,000
- Risk per trade: 1% = £100
- Stop distance: 40 points on FTSE
- Position size: £100 ÷ 40 = £2.50 per point (adjust for instrument specification)
If the stop required for structure is so wide that 1% risk means an impractically small position, the trade fails the plan — not because the signal was wrong, but because R:R and sizing together disqualify it.
Targets are not wishes
Targets in the plan reference the same levels methodology as entries: prior resistance, measured move from range height, next weekly level. "Take profit when it feels extended" is not a plan rule. Name the level or the trailing method (e.g. trail stop to breakeven after price closes beyond the midway point of the range).
Review when volatility shifts
When average daily range expands or contracts — common around major policy shifts — your historical R:R sample may no longer apply. Note in your weekly review whether stop distances have widened enough that your minimum R:R threshold needs recalibration.
Risk-reward planning completes the triangle with level definition and entry rules. Together they form the core of a signal-based plan you can test before committing capital.