Stop Loss, Target and Risk-Reward Explained

Stop Loss, Target and Risk-Reward Ratio Explained A trading strategy should define not only when to enter a trade, but also when to exit. Three important concepts are stop loss, target and risk-reward ratio. What is a stop loss? A stop loss is an exit level designed to limit a trade's loss if the market moves against the position. For example: Entry: ₹500 Stop loss: ₹490 The trader has defined a ₹10 price risk per share before considering other costs and execution factors. What is a target? A target is a predefined level at which a trader plans to exit a profitable position. For example: Entry: ₹500 Target: ₹520 The planned reward is ₹20 per share. What is risk-reward ratio? If the risk is ₹10 and the planned reward is ₹20, the risk-reward ratio is: 1:2 This means the planned reward is twice the planned risk. A favourable risk-reward ratio does not guarantee profitability. A strategy still needs a sufficient winning probability and controlled losses. Why this matters for automated strategies Automation makes rules precise. A computer cannot interpret: "Exit when the market looks weak." It needs measurable conditions. For example: Entry → ₹500 Stop → ₹490 Target → ₹520 These rules can be tested consistently. Risk management comes first Before worrying about how much a strategy can make, ask: How much can it lose? How frequently can losses occur? What is the maximum drawdown? How large is each position? What happens during unusual market conditions? Good strategy development begins with risk awareness.