Risk-Reward Ratio Explained With Examples

The risk-reward ratio compares how much you can lose on a trade with how much you aim to gain. It is one of the simplest tools in trading, and it helps you decide whether a trade is worth taking before you enter it.

What the ratio means

Risk is the distance from your entry price to your stop loss. Reward is the distance from your entry price to your take profit. The ratio is reward divided by risk.

Here is the example that the Risk-Reward Calculator uses by default. You buy at 1.1000, place the stop loss at 1.0950 and the take profit at 1.1100. The risk is 50 pips and the reward is 100 pips. The ratio is 100 / 50 = 2, usually written as 1:2. For every unit you risk, you aim to gain two.

The win rate you need to break even

A good ratio lets you be wrong more often than you are right. The break-even win rate is 100 / (1 + ratio), where the ratio is the reward for each 1 of risk. Ignoring costs, these are the results:

• 1:0.5 ratio: you need to win 66.7% of trades to break even.
• 1:1 ratio: you need to win 50%.
• 1:2 ratio: you need to win 33.3%.
• 1:3 ratio: you need to win 25%.

At 1:2, you break even by winning one trade in three. Win more often than that and, over many trades, you come out ahead. Win less often and you fall behind.

Expectancy: putting win rate and ratio together

The ratio alone does not say whether a strategy works. You also need the win rate. Expectancy tells you the average result per trade, measured in R, where 1R is the amount you risk. The formula is: win rate x reward in R - loss rate x 1R.

• 40% win rate at 1:2: 0.4 x 2 - 0.6 x 1 = +0.2R per trade. If 1R is $100, that is an average of $20 per trade over a long series of trades.
• 30% win rate at 1:2: 0.3 x 2 - 0.7 x 1 = -0.1R per trade. The strategy loses money slowly.
• 60% win rate at 1:1: 0.6 x 1 - 0.4 x 1 = +0.2R per trade.
• 70% win rate at 1:0.5: 0.7 x 0.5 - 0.3 x 1 = +0.05R per trade. A high win rate with a small reward leaves almost no margin.

These figures are averages over many trades. They do not tell you what happens on the next trade, and a positive expectancy still includes losing streaks.

A high ratio is not enough

It is easy to draw a take profit far away and call it a 1:5 trade. But the target has to be realistic. If price rarely travels that far, your real win rate will be low, and the trade can have a worse expectancy than a modest 1:1.5 target that is hit often. The ratio is only useful when the target and the stop are both based on what the market is actually doing, such as nearby support and resistance.

An example of a trade that fails the check

Suppose you want to buy at 1.1000. The nearest sensible stop loss is 1.0970, which is 30 pips away, and the nearest realistic target is 1.1020, which is 20 pips away. The reward is smaller than the risk: 20 / 30 is about 0.67, so the ratio is roughly 1:0.67.

The break-even win rate for that trade is 100 / (1 + 0.67), which is about 60%. Unless your strategy wins clearly more than six trades in ten, this setup is not worth taking. Finding that out before you enter is exactly what the ratio is for.

Costs change the picture

Spreads, commissions and slippage reduce your reward and add to your risk. A 2-pip spread is only a small cost on a 100-pip stop, but it is a fifth of a 10-pip stop. For very tight stops, costs can change a 1:2 trade into something much worse. Always compare the ratio after costs.

How to use the ratio in practice

• Find your stop loss first, at the point where the trade idea is clearly wrong.
• Look for a realistic target, such as the next area where price has reacted before.
• Calculate the ratio. If it is below the minimum you have set for yourself, skip the trade.
• Check the ratio against the win rate your strategy has actually achieved, ideally from a journal of real or demo trades.
• Remember that moving a stop loss, taking partial profits or trailing a stop all change the real ratio of the trade.

Common mistakes

• Choosing the target only to make the ratio look good.
• Ignoring the win rate and looking at the ratio alone.
• Moving the stop loss further away after entering, which lowers the ratio and raises the risk.
• Treating a small sample of trades as proof that a ratio and win rate will hold.

Try it yourself

Open the Risk-Reward Calculator, enter your entry, stop loss and take profit, and you will see the risk, the reward, the ratio and the win rate you need to break even in one place. Use it before every trade until checking the ratio becomes automatic.

Disclaimer: This article is for educational purposes only and does not constitute financial advice. Trading involves significant risk of loss.