Risk-to-Reward Ratio Explained

The risk-to-reward ratio compares how much you stand to lose on a trade if it hits your stop-loss with how much you stand to gain if it hits your take-profit. A trade risking 40 pips to make 80 has a ratio of 1:2. The ratio is one of the two numbers, together with win rate, that determine whether a trading approach makes money over time, and it is set at the moment you place the trade, not afterwards.

How the ratio is calculated

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

Suppose you buy EUR/USD at 1.0850 with a stop-loss at 1.0810 and a take-profit at 1.0950.

• Risk: 1.0850 − 1.0810 = 40 pips
• Reward: 1.0950 − 1.0850 = 100 pips
• Ratio: 100 ÷ 40 = 2.5, written as 1:2.5 or simply 2.5R

The letter R is shorthand for one unit of risk. A trade that hits a 2.5R target earns two and a half times what it would have lost at the stop. Thinking in R rather than in pips or currency makes trades on different pairs and with different stop sizes directly comparable.

The ratio can also be expressed in money. If the 40-pip stop represents a 50 loss in your account currency, the 100-pip target represents a 125 gain. Position size does not change the ratio; it changes the amount of money each R represents. The profit calculator converts pip distances into currency for any pair and lot size.

Why the ratio only makes sense with win rate

A high ratio is not a virtue by itself. A strategy that targets 5R will rarely reach its targets, and a strategy targeting 0.5R will hit them often. What matters is the combination.

The relevant measure is expectancy, the average amount you expect to make per trade, expressed in R:

Expectancy = (Win rate × Average win in R) − (Loss rate × Average loss in R)

With the loss always equal to 1R, the formula simplifies to:

Expectancy = (Win rate × Reward ratio) − (1 − Win rate)

Three strategies in the table produce +0.20R per trade with very different profiles. The 1:1 strategy needs to be right 60% of the time; the 1:3 strategy needs to be right only 30% of the time but must tolerate long losing streaks. Neither is better in the abstract; each requires a different temperament.

The breakeven win rate for any ratio is 1 ÷ (1 + reward ratio). At 1:2 it is 33.3%; at 1:3 it is 25%; at 1:1 it is 50%. Any strategy must beat its breakeven rate after spreads and slippage to be profitable.

Setting stops and targets from the chart

The ratio is a consequence of where the stop and target are placed, and both should be placed for structural reasons.

The stop-loss goes where the trade idea is wrong: beyond the support zone you bought at, beyond the swing low a reversal candle formed on, or beyond the range boundary a breakout came from. Placing it closer to improve the ratio means placing it inside the noise, where it will be hit by normal fluctuation. Guidance on placement is in What Is a Stop-Loss.

The take-profit goes at a level price could plausibly reach: the next resistance, the prior swing high, or a measured move. Placing it further away to improve the ratio means targeting a level price has no particular reason to reach. See What Is Take-Profit.

If, after placing both honestly, the ratio is below your minimum, the correct response is to skip the trade, not to adjust the levels.

A worked example with a decision

Suppose GBP/USD is in a 4-hour uptrend and pulls back to a support zone at 1.2700. A bullish pin bar forms with its low at 1.2685.

• Entry: 1.2720
• Stop: 1.2670, below the wick and the zone (50 pips)
• Nearest resistance: 1.2790 (70 pips), giving 1:1.4
• Next significant resistance: 1.2860 (140 pips), giving 1:2.8

A trader with a 1:2 minimum would either target 1.2860 and accept that price must clear the intermediate resistance at 1.2790, or skip the trade. Taking partial profit at 1.2790 and holding the remainder to 1.2860 is a third option, though it lowers the average ratio on the position. What the trader should not do is tighten the stop to 1.2695 to make the 1.2790 target a 1:2.8 trade; the stop would then sit above the pin bar's low, where the idea has not yet been invalidated.

Common mistakes

Judging trades by outcome instead of ratio. A 1:0.5 trade that wins was still a poor-quality trade. Over many repetitions, low-ratio trades need very high win rates to survive spread costs.

Moving the target closer as price approaches it. Cutting winners short reduces the realised ratio below the planned one. If the plan says 2R, the trade should be given the chance to reach 2R.

Widening the stop when price approaches it. This increases risk beyond the planned 1R and turns a controlled loss into a large one.

Ignoring costs. Spread and any commission reduce the effective reward and increase the effective risk. On a 20-pip stop with a 1.5-pip spread, the cost is 7.5% of the risk before the trade begins. Wider stops and higher time frames dilute this.

Applying one ratio to every strategy. Trend-following methods naturally produce higher ratios with lower win rates; range and mean-reversion methods produce the opposite. Set the minimum ratio to fit the method.

Combining the ratio with position sizing

The ratio defines the shape of a trade; position sizing defines its magnitude. Once the stop distance is known, the lot size is chosen so that the stop equals a fixed percentage of the account, usually 1–2%. A 50-pip stop and a 100-pip stop can both represent exactly 1% risk with different lot sizes. That step is explained in Position Sizing Explained, and the risk calculator shows how a given stop and lot size translate into account risk.

Key takeaways

• Risk-to-reward is the distance to take-profit divided by the distance to stop-loss; a 40-pip stop and 100-pip target is 1:2.5, or 2.5R.
• The ratio has meaning only in combination with win rate; expectancy = (win rate × reward ratio) − (loss rate).
• The breakeven win rate for a ratio is 1 ÷ (1 + ratio): 33% at 1:2, 25% at 1:3, 50% at 1:1.
• Place stops where the trade idea is invalidated and targets at levels price can reasonably reach; skip trades where the resulting ratio is below your minimum rather than forcing the levels.
• Costs such as spread reduce the effective ratio, especially on tight stops.
• Position sizing converts the stop distance into a fixed percentage of the account; the ratio and the size are separate decisions.