The risk‑reward ratio is one of the simplest and most useful tools a forex trader can learn. At its core it answers a basic question before you click “buy” or “sell”: how much do I stand to gain if the trade goes my way, compared with how much I stand to lose if it doesn’t? Learning to measure that relationship consistently helps you size positions, plan exits, and judge whether a trade fits your system and psychology.
Below I explain the idea step by step, show how to calculate it with real numbers, discuss how it interacts with win rate and expectancy, and offer practical guidance for choosing and applying ratios in different trading styles.
What the risk‑reward ratio means in practice
Imagine you mark an entry level, a stop‑loss (the price at which you will exit to limit loss) and a take‑profit (the price at which you will exit to lock in gains). The risk is the distance from entry to stop; the reward is the distance from entry to take‑profit. The ratio compares those two distances.
Saying a trade has a 1:2 risk‑reward ratio means you are risking one unit to make two units. It does not guarantee the trade will win twice as often — it only states the potential payoff relative to the potential loss when you place the trade.
How to calculate the ratio (with examples)
The basic formula for a long trade is:
Risk‑Reward Ratio = (Take‑Profit − Entry) / (Entry − Stop‑Loss)
For a short trade the distances are the same idea but measured downward.
A simple EUR/USD example illustrates this. Suppose you enter a long trade at 1.1000, place your stop‑loss at 1.0950 and your take‑profit at 1.1100. Your risk is 50 pips (1.1000 − 1.0950) and your reward is 100 pips (1.1100 − 1.1000). The ratio is 100 / 50 = 2, usually expressed as 1:2. In plain terms, you stand to make twice what you are risking.
Another example using gold (XAU/USD): entry $1,800, stop $1,750, take‑profit $2,000. Risk = $50, reward = $200, ratio = 200 / 50 = 4 → 1:4. That setup aims for larger moves and is typical of swing or position trades.
Why the ratio alone is not enough: win rate and expectancy
A risk‑reward ratio tells you nothing about how often a setup succeeds. Profitability combines ratio and win rate through the concept of expectancy — the average amount you can expect to make per trade. The standard formula is:
Expectancy = (Win% × Average Win) − (Loss% × Average Loss)
Suppose a system wins 40% of trades, average winning trade returns 2R (twice the risk) and average losing trade loses 1R. Expectancy per trade (in units of R) is (0.40 × 2) − (0.60 × 1) = 0.8 − 0.6 = 0.2R. If R equals $100, that’s $20 per trade on average. That positive expectancy is what matters over hundreds of trades.
You can also compute the breakeven win rate for a given ratio. If your average winner equals twice your average loser (1:2 ratio), you only need to win 1 / (1 + 2) = 33.3% of trades to break even before costs. Lower win rate strategies require higher ratios to remain profitable, and vice versa.
Choosing a realistic ratio for your style
There’s no universally “best” ratio — it depends on your timeframe, strategy and temperament. Scalpers operating in fast, noisy markets often accept smaller targets and tighter stops (e.g., about 1:1 to 1:1.5) because they trade frequently and rely on a higher win rate. Day traders commonly aim around 1:2. Swing or position traders who target larger moves may use 1:3 or higher, accepting a lower win rate for bigger winners.
The practical rule is to let market structure (support/resistance, recent swing points, ATR-based volatility) define your stop and target. Don’t force a preferred ratio by placing arbitrary stops or targets — choose levels that make sense and then calculate the ratio.
Position sizing using risk (R)
A key benefit of thinking in terms of risk is that you can size positions so that the dollar amount you would lose at the stop matches your risk tolerance. A common guideline is to risk a small fixed percentage of your account per trade — many traders use 1% or less.
Example: your account is $10,000 and you risk 1% = $100. You plan a trade with a 50‑pip stop. If one standard lot on the pair equals $10 per pip, a 50‑pip stop equals $500 risk at full lot size. To limit risk to $100 you trade 0.2 lots (because $500 × 0.2 = $100). The formula in general terms is:
Lot size = (Account × Risk%) / (Stop distance in pips × Dollar value per pip per lot)
Be aware that pip value varies by pair and by lot size, so calculate pip value for the instrument and account currency before sizing.
Practical habits that preserve your risk‑reward edge
Consistent habits improve how well theoretical ratios work in live trading. Define entry, stop and target before placing a trade and avoid moving the stop to “buy time,” because changing the stop changes your original ratio and invalidates your plan. Record every trade with entry, stop, target, and outcome so you can measure real win rates, average wins/losses and expectancy. Backtest or demo your approach until you have a statistically meaningful sample of trades (many traders look for 100+ trades before drawing firm conclusions).
Also factor trading costs: spreads, commissions and slippage reduce net reward and can materially change small‑target setups.
Common mistakes to avoid
A frequent error is choosing a target simply because it yields a nice ratio (for example, forcing a 1:4) while ignoring whether that target is realistic given current volatility and market structure. Another mistake is failing to include spread and commission in the calculation, which can turn a theoretical 1:2 trade into something much worse. Chasing a trade by moving your stop after entry or doubling down without recalculating risk ruins your documented R and position sizing. Finally, applying the same fixed ratio to every market and timeframe ignores the fact that volatility and behavior differ across instruments.
Risks and caveats
Using a risk‑reward framework helps manage trades, but it does not eliminate loss — trading always carries risk and you can lose money. The risk‑reward ratio is a planning tool, not a prediction. Real markets produce slippage, gaps, and changes in volatility that may push price past stops or prevent targets from being hit. Past backtest results do not guarantee future performance. This article is educational and not personalised trading advice; decide your own risk tolerance and consult a qualified advisor if you need tailored guidance.
Key Takeaways
- The risk‑reward ratio compares potential profit to potential loss on each trade; calculate it from entry, stop‑loss and take‑profit levels.
- Profitability depends on both the ratio and the win rate; use expectancy to measure a system’s long‑term edge.
- Size positions so the dollar risk per trade matches your account tolerance, and always factor in spread, commission and slippage.
- Keep stops and targets grounded in market structure, track results, and remember trading carries risk — past results are no guarantee of future performance.
References
- https://www.fpmarkets.com/education/trading-guides/complete-risk-reward-ratio-guide-for-forex-traders/
- https://www.dominionmarkets.com/best-risk-to-reward-ration-forex/
- https://smarttradingsoftware.com/en/calculators/risk-reward-ratio-calculator/
- https://www.xs.com/en/blog/risk-to-reward-ratio/
- https://www.babypips.com/learn/forex/reward-to-risk-ratio
- https://fbs.com/fbs-academy/traders-blog/risk-to-reward-ratio-meaning-formula-and-importance-for-trading
- https://www.investopedia.com/articles/stocks/11/calculating-risk-reward.asp