Risk-Reward Ratio
Risk Management
The risk-reward ratio compares the potential loss of a trade to its potential gain, helping traders take only setups where the reward justifies the risk.
What is the risk-reward ratio?
The risk-reward ratio measures how much a trader stands to lose against how much they stand to gain on a single trade, before it is even opened. It is calculated by comparing the distance from the entry price to the stop-loss (the risk) against the distance from entry to the take-profit target (the reward).
It’s usually written as a ratio like 1:2 or 1:3, meaning the potential reward is two or three times the amount being risked.
A worked example
Say a trader buys EUR/USD at 1.0850, places a stop-loss at 1.0820 (30 pips of risk), and a take-profit at 1.0910 (60 pips of potential reward). That trade has a risk-reward ratio of 1:2 — for every dollar risked, the plan is to make two dollars if the target is hit.
This matters because it changes how often a strategy needs to be right to stay profitable. With a 1:2 ratio, a trader can be wrong more often than they’re right and still come out ahead: winning just 40% of trades at 1:2 produces a net profit over a large enough sample, while winning even 60% of trades at a poor 1:0.5 ratio can still lose money overall.
Why it matters
The risk-reward ratio is a filter for trade quality, not a guarantee. It works alongside sound position sizing and honest technical analysis — a good ratio on a low-probability setup doesn’t make it a good trade. Most experienced traders look for a minimum ratio, often 1:1.5 or better, before considering a setup worth taking, and they combine this filter with realistic win-rate expectations from their own trading history, not wishful thinking.
Quick recap
- The risk-reward ratio compares potential loss to potential gain on a trade.
- A 1:2 ratio means risking $1 to try to make $2.
- Favorable ratios allow a strategy to be profitable even with a win rate below 50%.
- It should be assessed together with position sizing and a trade’s actual probability of success, not in isolation.
Trading forex and CFDs carries a high level of risk and may not be suitable for all investors. Past performance is not indicative of future results.