Risk-to-reward ratio is one of the simplest ways to describe the relationship between what a trader is prepared to lose and what a trade is expected to gain. It does not tell you whether a trade is good, and it cannot predict whether a target will be reached. What it can do is make the trade structure easier to evaluate before an order is placed.
What is a risk-to-reward ratio?
The ratio compares the distance from entry to stop loss with the distance from entry to take profit. If a trade risks 50 pips to target 100 pips, the reward-to-risk ratio is 2:1. The same relationship can be written as a risk-to-reward ratio of 1:2.
The calculation is based on price distance, not on whether the trade is likely to succeed. For a long trade, risk is the distance from entry down to the stop, while reward is the distance from entry up to the target. For a short trade, the directions are reversed.
How to calculate it
A simple formula is:
Reward-to-risk = target distance ÷ stop-loss distance
Suppose EUR/USD is entered at 1.1000 with a stop at 1.0950 and a target at 1.1100. The stop is 50 pips away and the target is 100 pips away, so the reward-to-risk ratio is 100 ÷ 50 = 2.0, or 2:1.
You can test the same calculation with the FOREXSIGNAL24 Risk / Reward Calculator. The calculator also displays the theoretical break-even win rate implied by the ratio.
Risk-reward and break-even win rate
The ratio can be translated into a theoretical break-even win rate before costs. At 1:1, a trader would need to win 50% of trades to break even if every winner and loser were exactly the planned size. At 1:2, the theoretical break-even win rate falls to about 33.3%. At 1:3, it falls to 25%.
That does not mean a 1:3 setup is automatically better than a 1:2 setup. A more distant target may be reached less often, and real trading includes spreads, commissions, slippage, partial exits and trades that do not close exactly at the planned levels.
Why the ratio should come after the stop-loss logic
A common mistake is to choose a desired ratio first and then force the stop loss or target to fit it. A more disciplined process is to identify the invalidation level for the trade idea, measure the stop distance, and only then assess whether the available target creates a reasonable relationship between risk and potential reward.
The stop-loss distance also affects position size. A wider stop generally requires a smaller position if the same amount of account risk is maintained. For that reason, risk-reward analysis works best together with position sizing rather than as a standalone number. See How to Use a Forex Position Size Calculator for a practical example.
Example: the same account risk, different stop distances
Assume a trader has a $5,000 account and decides that a particular trade should risk no more than 1%, or $50. One setup has a 25-pip stop; another has a 50-pip stop. If the pip value is the same, the second setup needs roughly half the position size to keep the dollar risk near $50.
The reward-to-risk ratio can remain identical even though the lot size changes. This is why the ratio describes the geometry of a trade, while position sizing controls how much account capital is actually exposed.
What risk-reward does not include
A clean ratio can hide several real-world variables. Spread increases the distance a trade may need to move before it becomes profitable. Commission reduces net results. Slippage can make an executed loss larger than the planned stop distance, especially during fast markets or gaps. Overnight financing can also matter for positions held across rollover.
Because of these factors, the theoretical break-even win rate should be treated as a simplified reference rather than a performance forecast. The actual break-even rate depends on realized winners, realized losses and total trading costs.
A practical pre-trade checklist
- Define the entry, stop and target from the trade plan.
- Measure the stop-loss and target distances.
- Calculate the reward-to-risk ratio.
- Size the position from the amount of account capital you are prepared to risk.
- Check spread, commission and possible overnight charges.
- Remember that planned prices may differ from actual execution.
Use the ratio as a planning tool, not a prediction
Risk-reward analysis is most useful when it forces the trade plan to become explicit. You know where the idea is invalidated, how far the target is from the entry, and what relationship exists between the two distances. That clarity can help compare setups consistently, but it cannot determine which trades will win.
To calculate the numbers directly, open the Risk / Reward Calculator. For position sizing, use the Position Size Calculator.