The risk–reward ratio
The previous lesson explained how position sizing connects a planned loss to your account risk. This lesson introduces the risk–reward ratio: a way to compare that planned loss with a potential gain. You will learn how to calculate it, interpret it alongside win rate, and recognise why an attractive ratio does not guarantee a successful outcome.
1. What the ratio measures
The risk–reward ratio compares the amount you plan to risk on a trade with the amount you aim to gain. Planned risk is usually measured from the entry price to the stop-loss level. Potential reward is measured from the entry price to the take-profit level. These are planned outcomes, not guarantees: actual execution, trading costs and changes to the trade can affect the final result.
In this lesson, the ratio is written as risk:reward. A ratio of 1:2 means the potential reward is twice the planned risk; 1:0.5 means it is half the planned risk. Some resources instead quote reward divided by risk as a single number. Under that convention, a risk:reward ratio of 1:2 becomes 2. Always check the convention before comparing figures.
2. Connect the ratio to position size
Before costs, calculate the ratio by comparing the entry-to-stop distance with the entry-to-target distance, using the same units for both. For example, a 25-pip stop distance and a 50-pip target distance give 25:50, which simplifies to 1:2. For a sell trade, the stop is normally above entry and the target below it; use the absolute distances rather than negative values.
The ratio does not tell you how much of your account is at risk. That depends on position size as well as the stop distance. Increasing the position size increases both the planned cash loss and potential cash gain, while leaving the price-distance ratio unchanged. This links directly to the previous lesson: assess the cash risk separately rather than treating a favourable ratio as permission to take a larger position.
3. Worked example: EURUSD
Consider a hypothetical EURUSD buy trade entered at 1.1000, with a stop-loss at 1.0980 and a take-profit at 1.1040. The stop distance is 20 pips and the target distance is 40 pips. Suppose the position is 0.50 standard lots, or 50,000 EUR. With EURUSD worth USD 10 per pip per standard lot, this position has a pip value of USD 5.
Excluding costs and assuming execution at the stated levels, the planned loss is 20 × USD 5 = USD 100. The potential gain is 40 × USD 5 = USD 200, giving a risk:reward ratio of 100:200, or 1:2. On a hypothetical USD 10,000 account, the planned loss is 1% of equity. This example illustrates the calculation only; it does not suggest suitable entry, stop, target or risk levels.
4. Read the ratio alongside win rate
A ratio cannot show whether an approach is profitable without information about how often gains and losses occur. In a simplified model with fixed outcomes and no costs, the break-even win rate is risk ÷ (risk + reward). For a 1:2 ratio, this is 1 ÷ 3, or approximately 33.3%. This is a mathematical threshold, not a forecast of the likelihood of winning.
For example, across 12 hypothetical trades with losses of USD 100 and gains of USD 200, four wins produce USD 800 and eight losses total USD 800. The result is zero before costs and negative after costs. In practice, outcomes vary, so realised average gains and losses matter more than target labels. A short run of results also provides limited evidence about what may happen in the future.
5. Understand the practical limits
Moving a target farther away makes the displayed ratio look more attractive, but it can also make that target less likely to be reached. Moving a stop closer reduces the calculated risk distance, yet ordinary price movement may trigger it sooner. A ratio therefore needs context: it describes the relationship between two levels, not whether those levels are realistic for the market conditions or the intended holding period.
Spread, commission where applicable, and overnight financing can reduce net reward or increase net loss; avoid counting a cost twice if it is already reflected in execution prices. Slippage and price gaps can also cause a stop-loss to execute beyond its specified level. On MT5, check order details and symbol specifications when calculating exposure. CFDs are leveraged and carry a high risk of loss. The next lesson explains why leverage requires a separate assessment.
- A 1:2 risk:reward ratio means potential reward is twice planned risk.
- Position size determines cash exposure; the ratio alone does not.
- Win rate, realised outcomes and costs matter alongside the planned ratio.
- Stop-loss levels do not guarantee execution prices or cap every loss.