The relationship between how much you risk on a trade and how much you stand to gain. A 1:2 risk-reward ratio means you risk $1 to potentially make $2.
What Is the Risk-Reward Ratio?
The risk-reward ratio (RRR) compares your potential loss to your potential gain on any single trade. If you set a stop-loss 30 pips below entry and a take-profit 90 pips above, your RRR is 1:3. You are risking 1 unit to gain 3. This ratio is fundamental because it determines how often you need to win to be profitable overall.
With a 1:2 ratio, you only need to win 34% of your trades to break even. With 1:3, you need just 26%. This is why traders who maintain favorable risk-reward ratios can be profitable even with a win rate below 50%.
Practical Example
You go long EUR/USD at 1.0850 with a stop-loss at 1.0820 (30 pips risk) and a take-profit at 1.0910 (60 pips reward). Your risk-reward ratio is 1:2. Over 100 trades with this setup and a 45% win rate: 45 winners at 60 pips = 2,700 pips gained; 55 losers at 30 pips = 1,650 pips lost. Net profit: 1,050 pips. Use the Profit/Loss Calculator to convert those pips into actual dollar amounts based on your position size.
Common Mistakes
The biggest mistake is moving your stop-loss further away or your take-profit closer during a trade, which destroys the original ratio. Another pitfall is using a favorable ratio with unrealistic targets. Setting a 1:5 ratio looks great on paper, but if the target requires a 500-pip move in a pair that averages 80 pips daily, the trade is unlikely to reach it. Always consider the Average True Range of the pair to set realistic targets.
Related Terms
Position Sizing
The process of determining how many lots or units to trade based on your account size, risk tolerance, and stop-loss distance. Proper position sizing ensures no single trade can cause catastrophic damage to your account.
Stop-Loss
An order that automatically closes a position at a predetermined price to limit losses. The most important risk management tool in forex trading.
Take-Profit
An order that automatically closes a position at a predetermined price to lock in profit. It is the profit-side counterpart to a stop-loss.
Money Management
The overall discipline of managing trading capital through position sizing, risk limits, and account rules to preserve capital and grow an account sustainably over time.
Ready to trade live?
XM Group. Our pick for beginners. Regulated by CySEC, ASIC, DFSA and IFSC, $5 minimum deposit, micro lots available.
75.33% of retail CFD accounts lose money when trading with this provider.