Risk-Reward Ratio Explained
The risk-reward ratio (R:R) compares how much you risk per trade to how much you aim to make. A 1:2 ratio means you risk R100 to make R200. It sounds simple — but most traders misunderstand how R:R interacts with win rate, and that's where accounts get destroyed.
What Risk-Reward Ratio Actually Means
R:R is calculated before you enter a trade. You define your stop-loss (risk) and take-profit (reward). If your stop-loss is 50 pips and your take-profit is 100 pips, your R:R is 1:2.
The ratio tells you how much you need to win to break even. At 1:2 R:R, you need to win 33% of your trades to break even. At 1:1, you need 50%. At 1:3, you need 25%.
Why 1:2 Isn't a Magic Number
Many trading courses teach that 1:2 is the minimum R:R. The logic: if you win more than 33% of trades at 1:2, you're profitable. But this ignores a critical reality: higher R:R targets have lower win rates.
A strategy targeting 1:2 R:R might have a 40% win rate — profitable. A strategy targeting 1:5 R:R might have a 15% win rate — also profitable. But a strategy targeting 1:2 with a 25% win rate is losing money.
R:R and win rate are linked. You can't set one without considering the other. The relationship depends on your strategy, instrument, and timeframe.
The Expectancy Formula
Expectancy is the single number that tells you if your strategy is profitable. It combines win rate and R:R into one metric:
Example: 45% win rate, 1:2 R:R, R100 risk per trade.
Expectancy = (0.45 × R200) - (0.55 × R100) = R90 - R55 = R35 per trade
Positive expectancy means profitable over time. Negative expectancy means you lose money regardless of how disciplined you are. This is the number that matters — not your R:R ratio alone.
High R:R vs High Win Rate
There are two paths to profitability:
Neither is better. The question is which fits your psychology and trading style. If you can't handle 10 losses in a row, don't trade a high-R:R trend-following strategy. If you can't take small profits, don't trade a high-win-rate scalping strategy.
Practical Application
When backtesting, track these numbers:
- ✓ Win rate per strategy per instrument
- ✓ Average win size vs average loss size (actual R:R)
- ✓ Expectancy per trade
- ✓ Maximum consecutive losses (for psychological prep)
The backtester calculates all of these automatically. Run the same strategy across multiple instruments to see how R:R and win rate vary — the same strategy can have 1:2 R:R on EURUSD but 1:1.5 on gold.