Risk reward ratio

What is Risk reward ratio in forex and CFD trading

The Risk-Reward Ratio (R:R Ratio) is a core metric defining the potential profit a trade is expected to yield relative to the potential loss the trader is willing to risk, calculated by dividing the distance to the stop-loss (risk) by the distance to the take-profit (reward). The Risk-Reward Ratio matters for real trading decisions because it governs a strategy’s profitability; trades with a higher R:R Ratio require a lower win rate to break even or be profitable, preserving capital. A trader verifies the Risk-Reward Ratio directly on their platform by measuring the distance in pips or points between the entry price, the stop-loss price, and the take-profit price before order execution, ensuring discipline.

Key facts about Risk reward ratio

• Definition: The comparison of the defined risk distance to the defined reward distance, often expressed as a ratio (e.g., 1:2).
• Calculation Unit: Measured in pips, points, or currency units, but must use the same unit for both the risk and reward components.
• Break-Even Win Rate: The minimum percentage of winning trades required to cover losses is determined by the R:R Ratio; for a 1:1 ratio, the required win rate is 50%.
• Typical Standard: Many professional traders target a minimum Risk-Reward Ratio of 1:2 or 1:3 to ensure profitability even with win rates below 50%.
• Risk Component: The distance from the entry price to the pre-determined stop-loss order.
• Reward Component: The distance from the entry price to the pre-determined take-profit order.
• Formula: R:R Ratio = Distance to Stop-Loss / Distance to Take-Profit, which is then inverted and expressed as 1:X.

How Risk reward ratio works in forex and CFD trading

The Risk-Reward Ratio works by mathematically formalizing the trade structure before execution, linking the protective stop-loss and the target take-profit levels to ensure that potential gain outweighs potential loss. For other trading terms, visit our full glossary.

Calculation follows these steps:

• Define Entry Price (P_Entry): Establish the exact price at which the trade will be entered.
• Define Stop-Loss Price (P_Stop): Establish the price where the trade will be closed to limit loss.
• Define Take-Profit Price (P_Target): Establish the price where the trade will be closed to realize profit.
• Calculate Risk Distance (D_Risk): Calculate the absolute distance between P_Entry and P_Stop in pips or currency units.
• Calculate Reward Distance (D_Reward): Calculate the absolute distance between P_Entry and P_Target in pips or currency units.
• Calculate the Ratio: Calculate the ratio D_Reward / D_Risk. If D_Reward is 40 pips and D_Risk is 20 pips, the ratio is 2, expressed as 1:2. This structure forces a disciplined approach, ensuring trades with inadequate profit potential relative to risk are avoided.

Example of Risk reward ratio with a real trade

This example calculates the Risk-Reward Ratio for a buy trade on EUR/USD and demonstrates the PnL consequence.

Instrument: EUR/USD (Buy Order) Entry Price: 1.10000 Stop-Loss Price: 1.09800 Take-Profit Price: 1.10600 Position size: 1 standard lot (100,000 units)

Risk-Reward Ratio Calculation: Risk Distance (D_Risk): 1.10000 – 1.09800 = 0.00200, or 20 pips. Reward Distance (D_Reward): 1.10600 – 1.10000 = 0.00600, or 60 pips. Ratio Calculation: 60 pips (Reward) / 20 pips (Risk) = 3. Risk-Reward Ratio Expression: 1:3.

PnL Impact (based on 1 standard lot value of $10/pip): Potential Loss (Risk): 20 pips × $10/pip = $200 Spread Cost: 0.2 pips × $10/pip = $2 Commission: $0.00 (zero commission structure) Total Risk: $200 + $2 = $202

Potential Profit (Reward): 60 pips × $10/pip = $600 Commission: $0.00 (zero commission structure) Net Reward: $600

Result: 1:3 Risk-Reward Ratio. The trader risks $202 (including spread) to potentially gain $600. Zero commission structure eliminates per-trade commission fees on both entry and exit, preserving the integrity of the calculated R:R Ratio.

How Risk reward ratio affects your cost and risk

The Risk-Reward Ratio is a direct risk management tool, influencing the overall financial stability of the trading account more than execution costs.

Risk reward ratio compared with related concepts

Risk-Reward Ratio vs Win Rate

The Risk-Reward Ratio is a measure of the profitability potential of an individual trade setup, calculated before entry, and is independent of the outcome of previous trades. Win Rate is the percentage of trades that are profitable over a series of trades, which is a historical measure of the strategy’s consistency. The two must be combined in a product (Expected Value) to determine overall system profitability; a high R:R Ratio allows for a lower Win Rate.

Risk-Reward Ratio vs Expectancy

The Risk-Reward Ratio is a simple comparison of potential size of gain versus potential size of loss for one trade. Expectancy (or Expected Value) is a sophisticated measure that combines the R:R Ratio with the strategy’s historical Win Rate and Loss Rate to calculate the average amount of money a trader can expect to gain or lose per unit risked over the long run. The R:R Ratio is a static plan, whereas Expectancy is a dynamic performance measure.

Broker differences in Risk reward ratio across the industry

Broker differences affect the Risk-Reward Ratio indirectly by influencing the actual distance realized on the stop-loss (due to slippage) and the target (due to spread widening).

How to verify Risk reward ratio on your trading platform

Verifying the Risk-Reward Ratio must be done before placing a trade, typically using visual tools or a simple calculator.

• Open Crosshair Tool: On the chart (MT4, MT5, or TradingView), activate the crosshair tool.
• Identify Entry: Place the crosshair on your proposed trade entry price.
• Measure Risk: Drag the crosshair to the proposed Stop-Loss level and note the distance in pips or points (Risk Distance).
• Measure Reward: Drag the crosshair to the proposed Take-Profit level and note the distance in pips or points (Reward Distance).
• Calculate Ratio: Divide the Reward Distance by the Risk Distance (e.g., 60 pips / 20 pips = 3).
• Confirm Trade: If the result is the desired R:R Ratio (e.g., 3 → 1:3), proceed to order entry.
• Input Orders: Enter the trade with the calculated Stop-Loss and Take-Profit values.
• Sanity check: The Take-Profit distance must always be greater than the Stop-Loss distance for the Risk-Reward Ratio to be greater than 1:1, which is generally required for long-term profitability.