What Is the Risk-Reward Ratio? How to Calculate It and the Effective Ratio After Spreads
You may think you are trading at a "1:2 risk-reward ratio" with a stop loss and take-profit in place, yet your account shows less profit than the math suggests. One cause of that gap is that the ratio calculation leaves out spreads and fees.
The risk-reward ratio is the ratio of the profit you aim for on a single trade to the loss you take if the trade goes against you.
This article explains how to calculate the risk-reward ratio and expected value, the effective ratio after costs, and how to choose a take-profit level from the chart, using USD/JPY and gold numbers.
Table of Contents
What Is the Risk-Reward Ratio?
The risk-reward ratio expresses how large the distance to your take-profit is relative to the distance to your stop loss. It is also called the risk/reward ratio or simply risk-reward.
With a 30 pips stop loss and a 45 pips take-profit, the profit is 1.5 for every 1 of loss, so it is written "1:1.5." A trade that aims for a larger profit than loss, often called "small loss, big gain," is one where the second number is greater than 1.
How to Calculate the Risk-Reward Ratio
Calculate the risk-reward ratio by dividing the take-profit distance by the stop-loss distance.
Risk-reward ratio = take-profit distance ÷ stop-loss distance
For example, suppose you buy USD/JPY at 150.00 yen, place the stop loss at 149.70 yen, and place the take-profit at 150.45 yen.
45 pips ÷ 30 pips = 1.5
The ratio is 1:1.5. Dividing by monetary amounts instead of price distances gives the same ratio.
If you trade 0.1 lot (10,000 units) in an account where 1 lot is 100,000 units, the loss if your stop loss is hit is 3,000 yen, and the profit if your take-profit is hit is 4,500 yen.
Calculating From Past Trades
Separately from the ratio of a trade you are about to enter, you can also calculate the ratio from the results of your past trades.
Realized risk-reward ratio = average profit ÷ average loss
If the average profit on winning trades is 6,000 yen and the average loss on losing trades is 4,000 yen, the realized ratio is 1:1.5.
Even if you enter orders at 1:2, the realized ratio will come out smaller than planned if you close manually before the take-profit is hit, or if your stop loss fills at a worse price than you specified. It is a good idea to compare your planned ratio with your realized ratio from time to time.
Expected Value Combined With Win Rate
The larger the ratio, the more likely you are to be profitable even with a low win rate. However, the farther away you place your take-profit, the more trades there will be where the price does not reach it and hits your stop loss instead.
For that reason, you need to judge a ratio together with the win rate. Expected value, which shows how much you gain on average per trade, is what you use to compare both at once.
Expected value = win rate × average profit − probability of losing × average loss
With a 40% win rate, a 30 pips stop loss, and a 45 pips take-profit, the expected value per trade is as follows.
0.4 × 45 pips − 0.6 × 30 pips = 0 pips
The ratio is 1:1.5, but at a 40% win rate you break even. Keeping the same 30 pips stop loss and changing the combination of win rate and ratio gives the following.
Expected value per trade for each combination of win rate and risk-reward ratio (30 pips stop loss, excluding costs)
| Win rate | Risk-reward ratio | Expected value per trade |
|---|---|---|
| 55% | 1:1 | +3.0 pips |
| 40% | 1:1.5 | 0 pips |
| 35% | 1:2 | +1.5 pips |
Among these three, the combination with the smallest ratio, 1:1 at a 55% win rate, has the highest expected value.
Spreads Lower the Ratio
The calculations so far do not include spreads or trading fees. In actual profit and loss, costs reduce your profit and increase your loss.
Chart Price Distances and the Spread
The candlesticks on the MT5 chart are drawn using the selling price (Bid). A buy order, however, fills at the buying price (Ask), so the moment you enter you start with an unrealized loss equal to the spread.
Suppose you are buying, with the stop loss placed just below a low on the chart and the take-profit placed just short of a high, and you measure those distances on the chart. If, on USD/JPY, the stop-loss distance on the chart is 30 pips, the take-profit distance is 45 pips, and the spread is 2 pips, your actual profit and loss is as follows.
Loss = 30 pips + 2 pips = 32 pips
Profit = 45 pips − 2 pips = 43 pips
The effective ratio is about 1:1.34, which is below the 1:1.5 shown on the chart.
The win rate at which you break even also needs to be recalculated using the price distances that include costs.
Break-even win rate = stop-loss distance ÷ (stop-loss distance + take-profit distance)
32 pips ÷ (32 pips + 43 pips) ≈ 42.7%
The calculation without costs gave 40%, so the same trade needs a win rate about 2.7 percentage points higher. If your win rate stays at 40%, the expected value drops from 0 pips to −2 pips per trade.
For sell orders, take-profit and stop loss are triggered on the Ask, so you need to be careful about where you place orders. How to place sell orders is covered in the section on placing take-profit.
The Narrower the Distance, the Bigger the Impact
The spread applies regardless of the stop-loss and take-profit distances, so the narrower the distances, the bigger the effect on the ratio. Here is a comparison of trades that are all 1:2 on the chart, with a 2 pips spread.
Effective risk-reward ratio for trades that are 1:2 on the chart, with a 2 pips spread
| Stop loss and take-profit on the chart | Effective risk-reward ratio | Break-even win rate |
|---|---|---|
| 5 pips / 10 pips | About 1:1.1 | About 46.7% |
| 10 pips / 20 pips | 1:1.5 | 40.0% |
| 20 pips / 40 pips | About 1:1.7 | About 36.7% |
| 50 pips / 100 pips | About 1:1.9 | About 34.7% |
The break-even win rate for a 1:2 trade without costs is 33.3%. For a trade with a 5 pips stop loss and a 10 pips take-profit, the required win rate is more than 13 points higher than that.
How wide the spread is varies by broker, account type, and time of day. For trades with narrow price distances, add the spread at that moment to your calculation before you place the order.
Calculating for Accounts With Trading Fees
For accounts that charge a trading fee in addition to the spread, convert the fee into pips and add it to the spread.
When you trade 1 lot (100,000 units) of USD/JPY, each 1 pip move changes your profit or loss by 1,000 yen. If the fee is 6 dollars per lot round trip, that is 900 yen at 150 yen per dollar, so in pips it works out as follows.
6 dollars × 150 yen ÷ 1,000 yen = 0.9 pips
If the spread is 0.6 pips, calculate the total cost as 1.5 pips.
Calculating With Gold
For gold (XAUUSD), you count price distances in dollars. In an account where 1 lot is 100 ounces, a 1 dollar move changes the profit or loss on 1 lot by 100 dollars.
For a buy with a 5 dollar stop loss and a 10 dollar take-profit on the chart and a spread of 0.4 dollars, the actual profit and loss is as follows.
Loss = 5 dollars + 0.4 dollars = 5.4 dollars
Profit = 10 dollars − 0.4 dollars = 9.6 dollars
The effective ratio is about 1:1.8, and the break-even win rate is 36%. At 0.01 lot (1 ounce), the loss if your stop loss is hit is 5.4 dollars, which is 810 yen at 150 yen per dollar.
Gold moves more than USD/JPY, so its stop-loss and take-profit distances also tend to be wider. However, spreads can widen around economic data releases, so calculate using the spread at that moment.
If you want to know the margin required for trading gold and a guideline for lot sizes, check out the article below.
Ratio When Your Stop Loss Slips
A stop-loss stop order is not always filled at exactly the price you specified. When the price jumps, such as right after an economic data release, the order can fill at a worse price than specified.
On a trade with a 30 pips stop loss and a 45 pips take-profit, if the stop loss slips by 10 pips, the loss on that trade is 40 pips. A single slip produces a loss close to the profit from one take-profit.
When you hold a position through a data release time, it is a good idea to set your lot size with the loss from slippage in mind.
How to Place Take-Profit
Another approach is to decide the ratio first and place the take-profit at twice the stop-loss distance. Even then, check on the chart that the take-profit price looks reachable.
Place It Just Short of a Recent High or Low
For a buy, place the take-profit just short of the recent high above. Sell orders tend to appear near recent highs, and the price can get pushed back.
If you place it exactly at the high, the price may fall back just a few pips short of it. Round prices such as 150.00 yen are likewise levels where the price tends to stall.
Take-Profit on Sells Is Triggered on the Ask
A sell position is closed at the buying price (Ask), so take-profit and stop loss are also triggered on the Ask. The chart displays the selling price (Bid), so if you place a take-profit exactly on a support line, it may not execute even when the price touches the line on the chart.
If the spread is 2 pips, place the take-profit for a sell at least 2 pips above the line on the chart. Conversely, a stop loss for a sell is more likely to be triggered before the price reaches the high on the chart, so place it farther from the high by more than the spread.
In MT5, you can display the Ask line from the chart properties. When placing a sell order, displaying the Ask line makes it easier to check your levels.
Check Whether ATR Says It Is Within Reach
Once you have decided on the take-profit level, check whether that distance is within reach of normal price movement. ATR is an indicator that displays the average size of price movement over a set period.
For example, if the 1-hour ATR is 12 pips and you place the take-profit at 48 pips, the price would have to move in the same direction for four consecutive 1-hour candles to reach it.
If you intend to close the trade within the day, it is a good idea to also check the daily ATR and confirm that the take-profit distance fits within a day's range of movement.
Skip Trades With an Insufficient Ratio
After deciding your stop loss and take-profit from the chart, calculate the ratio and skip any trade that falls below the standard you set yourself. Moving only the take-profit farther away to raise the ratio just increases the number of trades that never reach it.
Set your standard using the effective ratio after costs. If your rule is "an effective ratio of 1:1.5 or better," a trade that is 1:2 on the chart with a 10 pips stop loss and a 20 pips take-profit is exactly at the standard with a 2 pips spread.
When You Tighten the Stop Loss to Raise the Ratio
Moving your stop loss closer while leaving the take-profit as is also raises the ratio. If you tighten the stop loss from 30 pips to 10 pips, a trade with a 45 pips take-profit is 1:4.5 on the chart.
However, once you include a 2 pips spread, the loss is 12 pips and the profit is 43 pips, so the effective ratio is about 1:3.6. The narrower the distance, the bigger the effect of the spread.
Furthermore, if your stop loss falls within the range of normal price movement, you will be stopped out more often by wicks alone. Keep your stop loss at the price where you can conclude your forecast was wrong, and adjust the ratio through your take-profit placement and your skip standard.
Partial Closes Change the Ratio
Another method is to close part of the position once it is in profit and move the stop loss on the remainder to your entry price. In this case, the ratio of the trade as a whole changes.
For example, suppose that in an account where 1 lot is 100,000 units, you buy 0.2 lot of USD/JPY at 1:2, with a 30 pips stop loss and a 60 pips take-profit. If your stop loss is hit, the loss is 6,000 yen.
When you have 30 pips of unrealized profit and close half, 0.1 lot, you lock in a 3,000 yen profit. For the remaining 0.1 lot, you move the stop loss to your entry price.
If the remainder reaches the take-profit, the profits are 3,000 yen and 6,000 yen, for a total of 9,000 yen. The ratio is 9,000 yen ÷ 6,000 yen, or 1:1.5, which is lower than the 1:2 you would get by holding the full position.
On the other hand, even if the remainder falls back to your entry price, you keep the 3,000 yen profit. Both amounts exclude costs, so in practice you need to subtract the spread.
If you want to know how to partially close a position and move your stop loss in MT5, check out the article below.
Calculating the Ratio at EdgeGraph FX
EdgeGraph FX accounts are denominated in yen, so the profit and loss on closed trades is also recorded in yen. You can calculate your realized ratio directly from the amounts of your winning and losing trades.
Spreads are variable and change with the market, and they differ by symbol and account type. The spread for each symbol is listed on the "Currency Pairs & Spreads" page of the official website, so calculate using the numbers for the symbol you trade.
The Micro account and the Standard account have no trading fees.
The Pro account, on the other hand, charges a trading fee of 6 dollars per lot round trip, which for USD/JPY at 150 yen per dollar comes to about 0.9 pips. When calculating for the Pro account, add this fee to the spread.
The stop-out level is a 20% margin level for every account type, and it is not a substitute for a stop loss. To cut your loss at the ratio you planned, you need to place a stop order as a stop loss with each order.
Frequently Asked Questions
Summary
The risk-reward ratio is calculated by dividing the take-profit distance by the stop-loss distance. However, your actual profit and loss is determined by the effective ratio after subtracting spreads and fees, so it is important to calculate using price distances that include costs before you place an order.
EdgeGraph FX publishes the spread for each symbol and the trading fee for each account type on its official website. Plug in the numbers for the symbol you trade and calculate your effective ratio.
You can also start by placing an order with a stop loss and take-profit on a demo account and calculating the ratio from the distances shown in MT5.
Try placing orders with a stop loss and take-profit on an EdgeGraph FX demo account
Learn how to get started with a demo account here!
