Risk Reward Ratio

• The risk reward ratio compares the potential loss on a trade to its potential profit. A 1:2 ratio means risking one unit to target two. The ratio is calculated from stop loss and take profit distances, not from opinions about where the market will go.
• Win rate alone tells you nothing about whether a strategy makes money. A 35% win rate with a 1:3 ratio produces better long-term results than a 65% win rate with a 1:0.8 ratio. The maths always overrides the feeling.
• Every trade has a minimum win rate required to break even. That number comes directly from the ratio. Knowing it before entering tells you whether the setup is worth taking at its current structure.

One of the biggest misconceptions in forex trading is that winning most trades is what produces profit. It is not. Many consistently profitable traders lose more than half their trades. The reason they stay profitable is that their winning trades are materially larger than their losing ones. The risk reward ratio is the mechanism that makes this possible.

If you have not yet read Risk Management, start there before continuing.

Strip away the jargon and the concept is simple. Before a trade opens, two numbers exist on the chart: the distance to the stop loss and the distance to the target. The risk reward ratio is the relationship between those two distances. A 1:2 ratio means the target is twice as far from the entry as the stop. A 1:3 means three times. These are not aspirational figures. They are calculated from specific price levels already on the chart.

What the ratio does is connect those two decisions to the strategy's win rate. A strategy that wins 40% of its trades will profit over time at 1:2. The same win rate destroys capital at 1:0.8. The ratio determines whether the edge is real, and it is available to calculate before any money changes hands.

The formula

Risk reward ratio equals the distance from entry to take profit divided by the distance from entry to stop loss. A long trade entered at 1.3320 with a stop at 1.3270 and a target at 1.3420 has 50 pips of risk and 100 pips of potential reward. The ratio is 100 divided by 50, which is 1:2.

The calculation happens before the trade opens. Not after it looks like it is working.

The breakeven win rate

Every ratio implies a minimum win rate for the strategy to break even. The formula: required win rate equals risk divided by (risk plus reward).

At 1:3, a strategy needs to win only one trade in four to avoid losing money over time. This is the number that matters when evaluating whether a low win rate strategy is viable.

The market structure check

Before committing to any trade, check whether the nearest structural resistance actually supports the minimum ratio. If the stop loss is 50 pips but the next resistance is only 30 pips away, the trade offers below 1:1. No entry signal changes that arithmetic. Professional traders reject setups where the reward does not outweigh the risk, regardless of how clean the technical picture looks. The market determines the target. The trader checks whether the resulting ratio clears the minimum threshold.

Two traders, same number of trades

The following comparison, worked in full, shows why ratio matters more than win rate.

Trader A wins fewer than half the trades Trader B wins and earns more than twice the money. The ratio is doing the work, not the frequency of wins.

Expectancy

The combined effect of win rate and ratio produces expectancy: what the strategy earns per trade on average over a large sample. Van K. Tharp formalised this framework in Trade Your Way to Financial Freedom, expressing each trade's result as a multiple of the initial risk (R). A 60% win rate with 2R average wins and 1R average losses produces an expectancy of (0.6 × 2) minus (0.4 × 1) = 0.8R per trade. That is what the account actually grows by, on average, for every trade the strategy takes. Expectancy only has meaning over a sample of at least 30 trades; Tharp recommends 100 to 200 for statistical reliability.

The GBP/USD ascending channel documented in the Channels article in this series shows the ratio calculation applied to a verified trade. All data is confirmed in that article.

The breakeven win rate of 15.4% is worth reading carefully. The trade does not need to work most of the time. It needs to produce a winning result roughly once in every seven similar setups for the strategy to remain net flat across a large sample. Win it twice in seven and the account is growing at a meaningful rate despite losing five times.

This is not an argument for taking reckless trades. It is an argument for understanding what the channel structure actually offered on April 14, before a single pip moved. The ratio was available to calculate before the entry was placed.

The ratio connects the three decisions that define every trade: where to enter, where to be wrong, where to take profit. Without it, those three decisions exist as separate numbers. With it, they combine into a single measure of whether the trade makes sense.

A trader who checks the ratio before every entry will occasionally skip setups that look attractive. That is the point. A technically valid entry at a ratio below the strategy's minimum is not a trade worth taking. The chart pattern, the candlestick confirmation, none of that compensates for insufficient reward relative to the risk accepted.

The ratio also provides the only honest accountability for take profit behaviour. If a trader consistently closes winners before their targets, the actual ratio being achieved is lower than the planned ratio. Expectancy falls. The strategy underperforms not because the entries are wrong but because the exits are cutting short what the ratio assumed would be earned. For the full framework connecting ratio, expectancy, and capital preservation, read Risk Management alongside this topic.

1. The risk reward ratio is the distance from entry to target divided by the distance from entry to stop. It determines whether a strategy's win rate produces profit or loss over time, and it is calculated before any position opens.
2. Every ratio implies a breakeven win rate: 1:2 requires 33%, 1:3 requires 25%. A strategy operating above its breakeven win rate compounds gains. The two-trader comparison shows that a 35% win rate at 1:3 outperforms a 65% win rate at 1:0.8 over 100 trades.
3. The ratio is a filter. If the chart structure does not produce the minimum required ratio, the trade does not get taken. Adjusting the stop or inflating the target to force a better number produces a ratio on paper that has no connection to the actual trade.

The ratio tells you whether a trade is worth taking. The next step is calculating how much to put on it.

Position Sizing - Learn how to calculate the exact lot size for any trade based on your account balance, risk percentage, and stop loss distance, so the risk taken on every position matches the plan regardless of the setup's structure.

Risk Management - Revisit the full framework for protecting capital and see how the risk reward ratio fits into the broader system of account-level risk control.

Before your next three trades, ask three questions at the planning stage, before the position is open: how much am I willing to lose if the trade fails, where is the most logical profit target based on market structure, and does the potential reward justify the risk? If the answer to the third question is no, wait for a better setup. Then calculate the ratio for each of those three trades and write it down alongside the entry, stop, and target. After 20 trades, compare your planned ratios against your actual outcomes. The gap between those two numbers is where the work is. Successful traders do not trade every setup. They trade the setups where the potential reward is worth the calculated risk. Practice calculating the risk reward ratio on a demo account before applying it to live trades.