Risk-Reward Ratio Explained
What Risk-Reward Ratio Actually Measures
Risk-reward ratio compares how much you stand to lose on a trade against how much you stand to gain if it works out. It's one of the most important numbers in trading, because it determines whether a strategy can survive long enough to be profitable — regardless of how often it actually wins.
If you risk 50 pips to target 100 pips, your risk-reward ratio is 1:2 — for every unit you put on the line, you're aiming to get two units back.
The Risk-Reward Formula
Risk-Reward Ratio = (Entry to Take-Profit) ÷ (Entry to Stop-Loss)
Example: You buy XAUUSD at 2,300, with a stop at 2,285 and a target at 2,330. Your risk is 15 points, your reward is 30 points — a clean 1:2 ratio.
Example (forex): Long GBP/USD with a 25-pip stop and a 75-pip target on one standard lot. Risk = 25 × $10 = $250. Reward = 75 × $10 = $750. That's a 1:3 ratio.
Why a 70% Win Rate Can Still Lose Money
This is the part most beginners get backwards. Win rate on its own tells you almost nothing about profitability.
Consider a trader who wins 70% of the time but uses a 1:0.5 risk-reward ratio — risking 100 pips to make only 50. Over 100 trades: 70 wins × 50 pips = +3,500 pips, but 30 losses × 100 pips = -3,000 pips. Net result: only +500 pips despite winning the overwhelming majority of trades — and that's before spread and commission eat into it further.
Compare that to a trader winning only 40% of the time with a 1:3 ratio: 40 wins × 150 pips = +6,000 pips, against 60 losses × 50 pips = -3,000 pips. Net result: +3,000 pips — six times better, with a win rate almost half as high.
Win rate and risk-reward ratio only mean something when read together, never in isolation.
The Breakeven Win Rate Formula
Every risk-reward ratio implies a minimum win rate just to break even, before accounting for trading costs:
Breakeven Win Rate = Risk ÷ (Risk + Reward)
- 1:1 ratio → 50% win rate needed to break even
- 1:2 ratio → roughly 33% win rate needed
- 1:3 ratio → 25% win rate needed
This is a useful gut-check before ever opening a trade: if your realistic win rate for a given setup sits below the breakeven threshold for your chosen ratio, the trade doesn't have positive expectancy no matter how confident the entry looks.
Expectancy: The Number That Actually Matters
Risk-reward ratio applies to a single trade. Expectancy measures the average outcome per trade across your entire strategy, combining win rate and risk-reward into one number:
Expectancy = (Win Rate × Average Win) − (Loss Rate × Average Loss)
Example: A 40% win rate with an average win of $300 and a 60% loss rate with an average loss of $100:
(0.40 × $300) − (0.60 × $100) = $120 − $60 = +$60 expected value per trade
A positive expectancy means the strategy is statistically profitable over a large enough sample of trades. A negative expectancy means it isn't — regardless of how often it "feels" like it's working in the short term.
Choosing a Ratio for Your Trading Style
- 1:1 to 1:1.5 — suits scalping or quick trades where win rate tends to run higher.
- 1:2 — a balanced baseline that fits most day trading setups and stays profitable even below a 40% win rate.
- 1:3 or higher — better suited to trending markets or swing setups, where fewer trades hit target but each one pays significantly more.
There's no single "correct" ratio — the right one depends on your measured win rate for a given strategy, not a theoretical target picked in advance.
For how to actually place the stop-loss and take-profit levels behind these ratios, see Stop-Loss and Take-Profit Strategies.
Practical Notes Before You Trust the Math
- Factor in spread and commission. They quietly reduce your real ratio, especially on smaller targets.
- Don't move your stop-loss after entry. Doing so invalidates the ratio you planned the trade around.
- Backtest before trusting a ratio. Your true win rate for a given setup only becomes reliable after a meaningful sample of trades — not a handful of recent wins or losses.
- Position size still matters. A great ratio on an oversized position can still end a trading account.
Combine this with proper sizing in Position Sizing: How Much Should You Risk Per Trade?.
Running the Numbers on Two Different Strategies
Strategy A wins 70% of the time but only targets a 1:0.5 risk-reward (risking $20 to make $10). Over 100 trades: 70 wins × $10 = $700, minus 30 losses × $20 = $600. Net profit: $100.
Strategy B wins only 40% of the time but targets 1:2.5 (risking $20 to make $50). Over 100 trades: 40 wins × $50 = $2,000, minus 60 losses × $20 = $1,200. Net profit: $800.
Despite losing far more often, Strategy B is dramatically more profitable — a genuinely counterintuitive result until you see the actual math laid out. This is exactly why win rate alone is a misleading way to judge a trading strategy without also factoring in the risk-reward ratio it's paired with.
Frequently Asked Questions
What is a good risk-reward ratio in forex?
There's no universal answer — it depends on your actual win rate. A 1:1 ratio can be excellent with a 60% win rate, while a 1:3 ratio may only be breakeven around a 25% win rate. Many traders use 1:2 as a practical minimum, since it stays profitable even with a win rate below 40%.
How do you calculate risk-reward ratio?
Divide your potential reward by your potential risk: Risk-Reward Ratio = (Entry to Take-Profit) ÷ (Entry to Stop-Loss). Risking 50 pips to target 100 pips gives a 1:2 ratio.
Can a high win rate strategy still lose money?
Yes. A trader winning 70% of trades but risking twice as much as they target on each winner can still lose money overall, because the average loss outweighs the average win. Win rate alone doesn't determine profitability — it has to be read alongside risk-reward ratio.
What is the breakeven win rate formula?
Breakeven Win Rate = Risk ÷ (Risk + Reward). For a 1:2 risk-reward ratio, that's roughly 33% — meaning you only need to win about a third of your trades to break even, before accounting for spread and commission.