Risk & Money ManagementR:RReward-to-Risk Ratio
Risk-Reward Ratio
The ratio between the distance from entry to stop loss and the distance from entry to profit target.
What Risk-Reward Ratio means
The risk-reward ratio compares what a trade can lose if the stop is hit against what it can make if the target is reached. It is measured in pips, in points or directly in account currency, and is conventionally written risk first, so 1:3 means risking one unit to pursue three. Because it is defined entirely by the placement of the entry, the stop and the target, it is known before the trade is taken, which is what makes it useful as a filter.
The ratio only becomes meaningful when paired with the win rate, since the two jointly determine expectancy. The break-even win rate is 1 divided by (1 plus the reward multiple), so a 1:3 trade needs to win only 25 percent of the time to cover its losses. The practical caveat is that stretching a target to improve the ratio usually lowers the frequency with which it is reached, and both legs must be measured net of spread and commission rather than on raw chart distances.
Worked example
Buying EUR/USD at 1.0850 with a stop at 1.0820 and a target at 1.0940 risks 30 pips to make 90 pips, a ratio of 1:3, which breaks even at a win rate of 25 percent before trading costs.
Related terms
- Win RateThe percentage of closed trades that finish in profit, calculated as winning trades divided by total trades.
- ExpectancyThe average profit or loss a system produces per trade given its win rate and its average win and loss sizes.
- Stop LossA resting order that closes an open position once price reaches a set level, capping the loss on that trade.
- Take ProfitA resting limit order that closes an open position once price reaches a chosen profit level.
- Position SizingThe process of choosing how many lots to trade so that a losing trade costs a predetermined amount of capital.
Frequently asked questions
What does Risk-Reward Ratio mean in forex trading?
The ratio between the distance from entry to stop loss and the distance from entry to profit target.
How does Risk-Reward Ratio work in practice?
The ratio only becomes meaningful when paired with the win rate, since the two jointly determine expectancy. The break-even win rate is 1 divided by (1 plus the reward multiple), so a 1:3 trade needs to win only 25 percent of the time to cover its losses. The practical caveat is that stretching a target to improve the ratio usually lowers the frequency with which it is reached, and both legs must be measured net of spread and commission rather than on raw chart distances.
What is an example of Risk-Reward Ratio?
Buying EUR/USD at 1.0850 with a stop at 1.0820 and a target at 1.0940 risks 30 pips to make 90 pips, a ratio of 1:3, which breaks even at a win rate of 25 percent before trading costs.
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