Risk–Reward Ratio
Definition
The risk–reward ratio compares how much you are willing to lose on a trade versus how much you expect to gain if it succeeds. A 1:2 risk–reward ratio means risking one unit to potentially gain two. While a favourable ratio can improve long-term outcomes, it only works if trades are executed reliably and costs are controlled, making broker conditions an important factor.
In Plain English
In plain terms, the risk–reward ratio answers the question: ‘Is this trade worth taking?’ It compares the size of a possible loss to the size of a possible gain. If a trade risks £100 to make £300, the risk–reward ratio is 1:3. The ratio helps traders judge whether the potential upside justifies the downside.
How It Works
- You identify your entry price for a trade.
- You define a stop-loss level that limits how much you are willing to lose.
- You define a target or take-profit level where you would exit with a gain.
- The distance from entry to stop defines the risk.
- The distance from entry to target defines the reward.
- The ratio of these two distances is the risk–reward ratio.
- Execution costs such as spread and slippage affect both risk and reward.
- The effective risk–reward may differ from the planned ratio once costs are included.
Why This Matters for Traders
Risk–reward ratio helps traders think probabilistically rather than emotionally. A strategy does not need a high win rate if the average winning trade is larger than the average losing trade. However, focusing on the ratio alone can be misleading if execution quality, volatility, or costs make targets difficult to reach. Risk–reward works best when combined with realistic expectations and disciplined risk control.
Common Misunderstandings
- A high risk–reward guarantees profitability: win rate and execution still matter.
- Bigger targets always mean better trades: unrealistic targets reduce the chance of success.
- Risk–reward is fixed once set: spreads, slippage, and volatility can change outcomes.
- The ratio replaces risk management: position sizing and stops remain essential.
- All brokers support the same risk–reward outcomes: costs and execution differ.
How This Affects Broker Choice
Broker conditions determine whether planned risk–reward ratios are achievable in practice. When comparing brokers, users should consider:
• Typical spreads and how they affect stop and target distances.
• Slippage frequency on stops and take-profit orders.
• Availability and behaviour of take-profit and stop-loss orders.
• Execution reliability during volatile periods.
• Platform tools for visualising risk–reward before placing trades.
From a monetisation and comparison perspective, risk–reward connects strategy planning to broker execution quality, supporting links to broker reviews and comparisons focused on costs and order handling.
Risks & Common Mistakes
• Setting ambitious risk–reward targets without accounting for market volatility.
• Ignoring how spreads widen and reduce effective reward.
• Using tight stops to improve the ratio, increasing stop-out frequency.
• Assuming take-profit orders always execute at the intended level.
• Choosing brokers whose costs distort planned ratios.
Risk note: even with favourable risk–reward ratios, trading losses can occur frequently, and poor execution can materially worsen realised outcomes.
Real-World Example
You plan a trade with a £50 stop loss and a £150 take-profit target.
• The planned risk–reward ratio is 1:3.
• After accounting for spread and typical slippage, the effective reward is closer to £130.
The practical risk–reward becomes closer to 1:2.6. This difference highlights why broker costs and execution matter when evaluating trades.
What to Check Before Trading
- How do spreads affect stop and target placement?
- Is slippage common on stop-loss or take-profit orders?
- Are take-profit orders executed reliably?
- Does the platform show risk–reward visually before trade entry?
- How does volatility affect achievable targets?
- Are costs transparent enough to calculate effective ratios?
- Is execution quality consistent across instruments?
Related Concepts
The stop-loss level defines the risk side of the ratio.
The take-profit level defines the reward side of the ratio.
Position sizing controls how much capital is exposed at the chosen risk level.
Spread reduces effective reward and increases effective risk.
Slippage can distort both risk and reward beyond planned levels.
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Risk Warning: This website does not provide financial, investment, or trading advice. All information is for educational purposes only. Trading and investing involve substantial risk of loss. You should carefully consider your financial situation and consult with qualified professionals before making any financial decisions.