The risk-reward ratio (R:R) explained simply

Before you enter a trade, you know three prices: your entry, your stop and your target. The risk-reward ratio, often written R:R, links those three numbers. It answers a simple question: for every dollar I risk, how much can I hope to make if the trade works?

How to calculate R:R

For a sell, just flip the direction: (Entry − Target) ÷ (Stop − Entry). The result is expressed as a multiple of the risk. A trade is called “1:2” or “2R” when the targeted gain is twice the possible loss.

It works the same way on a sell. Say you sell gold at $3,320 after a rejection below resistance. Your stop is at $3,336, above the last swing high, and your target is the next support at $3,280. You risk $16 per ounce to make $40: 40 ÷ 16 = 2.5, a ratio of 1:2.5.

The minimum win rate

R:R alone does not tell you whether a strategy makes money. You need to combine it with your win rate, the percentage of trades that reach the target. There is a threshold below which you lose money over the long run, and it is very simple to calculate.

Take the 1:2 case. Out of three trades, if only one wins, you make 2R and lose 2 × 1R: you end up flat. That is indeed 1 ÷ (1 + 2) = 33.3%. Above that rate you are profitable; below it you lose, even with a good ratio.

The R:R traps

It is tempting to always aim for 1:5 or 1:10. On paper, you would only need to win one time in six or one time in eleven. In practice, a very distant target is rarely reached, and your real win rate collapses. Ratio and win rate are linked: when one goes up, the other almost always goes down.

• Unrealistic target: put it on a logical level, such as resistance or a previous high, not at a distance chosen to make the ratio look good.
• Stop too tight: moving the stop closer improves the displayed ratio, but sharply increases the odds of being taken out by noise.
• Forgotten costs: the spread and commission shrink the gain and enlarge the loss, so they degrade your real ratio, especially on small trades.
• Early exits: if you often close your winners halfway, your real R:R is far lower than your planned R:R.

There is a subtler trap too: the ratio ignores how likely each price is to be reached. Two 1:2 trades can be very different. In the first, the target sits just before major resistance; in the second, it is placed beyond it, where price has already turned back three times. Same number, very different trade quality. That is why you always look at the chart before the ratio.

Costs deserve a concrete calculation. On a EUR/USD trade with a 10-pip stop and a 20-pip target, a 1-pip spread brings the real gain down to about 19 pips and pushes the real loss up to about 11 pips. The displayed 1:2 ratio then drops to about 1:1.7, and the win rate you need rises from 33.3% to nearly 37%. The shorter your stop, the more costs weigh.

Using R:R to filter your trades

The most useful thing the ratio does is filter. Before each trade, find your logical stop and your logical target, then calculate the ratio. If it is below what your strategy requires, you pass. Many traders set themselves a minimum of 1:1.5 or 1:2, but the right threshold depends on your measured win rate.

In the next lesson, you will see how to combine win rate and ratio into a single number, expectancy, which tells you whether your strategy makes or loses money on average per trade.