Key Concept
Risk-reward ratio (R:R) is the relationship between how much you risk on a trade versus how much you stand to gain. A 1:2 ratio means risking $100 to potentially make $200. This concept is more important than your win rate for long-term profitability.
What is Risk-Reward Ratio?
The risk-reward ratio compares the potential loss (risk) to the potential profit (reward) of a trade. It's expressed as risk:reward or R:R.
Risk-Reward Ratio Formula
R:R = Potential Profit / Potential Loss
Example: Risk 50 pips to make 100 pips = 1:2 ratio
Risk $100 to make $300 = 1:3 ratio
Real Trade Example
- Entry: EUR/USD at 1.2000
- Stop-Loss: 1.1950 (50 pips risk)
- Take-Profit: 1.2100 (100 pips profit)
- Risk: 50 pips
- Reward: 100 pips
- R:R Ratio: 100/50 = 1:2
For every $1 you risk, you aim to make $2 profit.
Why Risk-Reward Ratio Matters
Many beginners focus exclusively on win rate ("I need to win 80% of my trades!"). This is backwards thinking. Profitability = Win Rate × Average Win - Loss Rate × Average Loss.
Win Rate vs Risk-Reward Comparison
Trader A: 80% Win Rate, 1:1 R:R
- 10 trades: 8 wins × $100 = $800
- 2 losses × $100 = -$200
- Net Profit: $600
Trader B: 40% Win Rate, 1:3 R:R
- 10 trades: 4 wins × $300 = $1,200
- 6 losses × $100 = -$600
- Net Profit: $600
Same profit with half the win rate! Trader B can be wrong 60% of the time and still match Trader A's results.
The Professional's Secret
Professional traders often have win rates between 40-60%. Their profitability comes from letting winners run (large gains) and cutting losers quickly (small losses). A 1:3 risk-reward ratio means you only need to win 25% of trades to break even!
How to Calculate Risk-Reward Ratio
Step-by-Step Process
- Identify Entry Price: Where you'll enter the trade
- Determine Stop-Loss: Where you'll exit if wrong (invalidation point)
- Calculate Risk in Pips: Entry - Stop-Loss
- Set Profit Target: Based on technical levels or R:R multiple
- Calculate Reward in Pips: Take-Profit - Entry
- Divide Reward by Risk: This gives your R:R ratio
R:R Calculator
Optimal Risk-Reward Ratios
| R:R Ratio | Breakeven Win Rate | Typical Use Case | Difficulty |
|---|---|---|---|
| 1:1 | 50% | Scalping, very short-term | Easy to achieve |
| 1:1.5 | 40% | Day trading | Moderate |
| 1:2 | 33% | Day/Swing trading (Recommended) | Achievable |
| 1:3 | 25% | Swing trading | Challenging |
| 1:4 | 20% | Position trading | Difficult |
| 1:5+ | 16.7% | Rare exceptional trades | Very difficult |
Recommended Starting Point
Beginners should aim for 1:2 minimum. This means if you risk 50 pips, target 100 pips profit. With a 1:2 ratio, you only need a 33% win rate to break even, and anything above that is profit.
Win Rate and R:R Relationship
Understanding the mathematical relationship between win rate and risk-reward ratio is crucial for realistic expectations.
Breakeven Win Rate Formula
Breakeven Win Rate = Risk / (Risk + Reward)
For 1:2 ratio: 1 / (1 + 2) = 33.33%
For 1:3 ratio: 1 / (1 + 3) = 25%
Profitability Table
| Win Rate | 1:1 R:R | 1:2 R:R | 1:3 R:R |
|---|---|---|---|
| 30% | -40% loss | -10% loss | +50% profit |
| 40% | -20% loss | +20% profit | +80% profit |
| 50% | Breakeven | +50% profit | +125% profit |
| 60% | +20% profit | +80% profit | +180% profit |
Key Insight
Notice how a mediocre 40% win rate becomes highly profitable with a 1:3 risk-reward ratio (+80%), while a good 60% win rate with 1:1 risk-reward only produces +20% profit. R:R ratio multiplies your results.
How to Set Realistic Profit Targets
Method 1: Technical Levels
Set your take-profit at logical technical levels where price is likely to reverse.
- Support/Resistance: Previous highs/lows
- Round Numbers: 1.2000, 1.3000, etc.
- Fibonacci Levels: 38.2%, 61.8%, etc.
- Trend Lines: Major ascending/descending lines
- Moving Averages: 200 EMA, 50 SMA, etc.
Method 2: Multiple Ratio
Set take-profit at a fixed multiple of your risk, regardless of technical levels.
Multiple Ratio Example
- Entry: 1.2000
- Stop-Loss: 1.1950 (50 pips risk)
- Target at 2x: 1.2100 (100 pips = 1:2 ratio)
- Target at 3x: 1.2150 (150 pips = 1:3 ratio)
Method 3: Partial Profit Taking
Scale out of positions at multiple levels to balance secured profits with letting winners run.
Scaling Out Strategy
- 50% at 1:1.5 R:R - Secure some profit early
- 25% at 1:2.5 R:R - Bank substantial gains
- 25% at 1:4+ R:R - Ride extended moves
Benefit: Even if price reverses, you've locked in profit from the first exit.
Common Risk-Reward Mistakes
Mistake #1: Chasing Unrealistic Ratios
Targeting 1:10 risk-reward sounds great but is rarely achievable. Setting unrealistic targets means most trades will reverse before reaching your target. Better to achieve 1:2 consistently than miss 1:5 repeatedly.
Mistake #2: Moving Take-Profit Closer
When price approaches your target, resist the temptation to exit early "to secure profit." This destroys your R:R ratio and makes profitable trading impossible. Stick to your plan.
Mistake #3: Ignoring Spreads and Commissions
If you target 1:2 but spreads/commissions cost 3 pips, your real ratio is worse. Account for trading costs in your R:R calculations.
Mistake #4: Not Measuring Actual R:R
Many traders set 1:3 targets but average 1:1.2 due to premature exits and moved stops. Track your actual realized R:R, not just your intended R:R.
Best Practice Checklist
- Set minimum 1:2 ratio for every trade
- Use technical levels to validate your targets
- Never adjust stops or targets mid-trade (except trailing stops in profit)
- Track actual realized R:R in your trading journal
- Accept that some trades will stop out - that's the cost of pursuing good ratios
- Don't force trades that don't offer good R:R