What the risk-reward ratio means
The risk-reward ratio in trading compares the amount you are prepared to lose on a trade with the amount you expect to gain if it works out. It is written as two numbers, such as 1:2 or 1:3. The first number is your risk — the distance from your entry to your stop-loss. The second is your reward — the distance from your entry to your profit target. A 1:2 ratio simply means you are risking one unit to potentially make two.
Crucially, the ratio is measured in the same units on both sides, almost always in pips or in cash. If your stop-loss sits 20 pips from entry and your take-profit sits 40 pips from entry, your risk-reward ratio is 20:40, which simplifies to 1:2. The actual lot size does not change the ratio, because it scales both the potential loss and the potential gain by the same amount.
Traders also describe reward in terms of R, where one R is the amount risked on the trade. A target at twice your risk is a 2R target; hitting it is a 2R win. Thinking in R lets you compare trades of very different sizes on a level footing, because every trade is measured against its own risk.
How to calculate your risk-reward ratio
Calculating the ratio takes three prices you should already know before you enter: your planned entry, your stop-loss, and your profit target. Risk is the distance from entry to stop. Reward is the distance from entry to target. Divide the reward distance by the risk distance and you have the ratio.
Here is a worked example, with illustrative numbers. You plan to enter EUR/USD at 1.1000, place a stop-loss at 1.0980, and set a take-profit at 1.1060. Your risk is 20 pips (1.1000 down to 1.0980) and your reward is 60 pips (1.1000 up to 1.1060). That gives a risk-reward ratio of 20:60, or 1:3 — you are risking one to make three.
Note what the ratio does not tell you: how likely either outcome is. A 1:5 ratio looks attractive on paper, but if the target is so far away that price rarely reaches it, the trade can still lose money over time. The ratio describes the shape of a single trade's payoff, not the probability of winning it. That is why it must always be read alongside your win rate.
Why the ratio means nothing without your win rate
A risk-reward ratio is only half of the equation. The other half is your win rate — the percentage of trades that reach their target rather than their stop. The two combine to produce your expectancy: the average amount you can expect to win or lose per trade over a long series.
The relationship is intuitive once you see the break-even point. With a 1:1 ratio, you need to win more than half your trades just to break even before costs. With a 1:2 ratio, you only need to win about one trade in three to break even, because each winner pays for two losers. With a 1:3 ratio, winning roughly one in four covers your losses. A higher reward multiple lowers the win rate you need, but it usually comes with a lower win rate in practice, because more distant targets are reached less often.
This trade-off is the heart of the matter. A scalping style might run a 1:1 ratio with a 60% win rate; a trend-following style might run 1:4 with a 30% win rate. Both can be profitable, and both can fail. Neither the ratio nor the win rate is meaningful in isolation — only their combination tells you whether a strategy has a positive edge.
Turning risk-reward into expectancy
Expectancy puts a number on whether a strategy makes money on average. A simple way to express it: expectancy per trade equals (win rate multiplied by average win) minus (loss rate multiplied by average loss). If the result is positive, the strategy has a mathematical edge over many trades; if it is negative, no amount of discipline will make it profitable.
Consider an illustrative example. Suppose you risk one R per trade, your targets are at 2R, and you win 40% of the time. Out of 100 trades, 40 winners at +2R produce +80R, and 60 losers at -1R produce -60R. The net is +20R over 100 trades, or an average of +0.2R per trade. Lower the win rate to 30% with the same 1:2 ratio and the maths flips negative, showing how sensitive the outcome is to both inputs.
Two cautions keep this honest. First, costs are real: the spread and any commission widen your effective risk and shrink your reward, so a 1:2 trade on the chart can be closer to 1:1.7 after costs. Second, these are averages over a large sample — any short run of trades can look very different. Leveraged forex and CFD trading carries a high risk of loss, and a positive expectancy reduces, but never removes, that risk.
Using risk-reward sensibly in real trading
The most common mistake is choosing a position size first and then setting a target wherever it produces a flattering ratio. The disciplined order is the reverse: find a logical stop-loss level on the chart, find a realistic target the market can plausibly reach, and only then read off the ratio that results. If that ratio is poor, the answer is to skip the trade, not to move the stop closer or the target further to manufacture a better number.
Once your stop distance is fixed, position sizing and risk-reward work together. You decide how much of your account to risk — many traders use a small fixed percentage, an approach covered in our guide to the 1% rule — and then a position size calculator turns your stop distance into the correct lot size. The ratio shapes the reward; your sizing rule caps the risk. The two are separate decisions that should never be blurred.
Avoid chasing extreme ratios for their own sake. A 1:10 target that price almost never reaches will quietly bleed an account through repeated small losses, while a realistic 1:1.5 or 1:2 that fits the actual market structure can be far more durable. Targets should be justified by where price is likely to stall — prior highs and lows, round numbers, support and resistance — not by the ratio you wish you had.
Finally, the only way to know your true ratio and win rate is to measure them. Recording every trade in a trading journal — the planned ratio, the actual exit, and the result in R — reveals whether your real expectancy matches your plan. Many traders discover their average winner is smaller than intended because they take profit early, quietly turning a planned 1:2 into a much weaker 1:1.2 that needs a far higher win rate to stay profitable.