Risk and reward
What you learn in 3 minutesA reader asked: if I win only four trades out of ten, can I still come out ahead? The answer depends on how much you make when you win compared with how much you lose when you lose. That relationship is the risk-to-reward ratio, and it decides the hit rate you need before costs. This lesson shows the arithmetic on USD/ZAR, using rand figures, so you can see what a 1:2 ratio does to a series of ten trades.
1:2 ratio with 4 wins out of 10
| Step | Amount | Note |
|---|---|---|
| Stop distance | 20 pips | the distance from entry to stop, chosen before the trade |
| Target distance | 40 pips | twice the stop distance, so the ratio is 1:2 |
| Position size | 0.10 lots | a standard lot is 100,000 units; 0.10 lots is 10,000 units |
| Value of one pip | R1.00 | for 0.10 lots on USD/ZAR at about 18.4100, one pip is about R1.00; this varies with the rate |
| Loss on one losing trade | R20.00 | 20 pips × R1.00 per pip |
| Gain on one winning trade | R40.00 | 40 pips × R1.00 per pip |
| Six losing trades | −R120.00 | 6 × R20.00 |
| Four winning trades | +R160.00 | 4 × R40.00 |
| Net result before costs | +R40.00 | R160.00 − R120.00 |
Your broker may round pip values, charge a spread, commission or swap, and quote a different USD/ZAR rate. Those costs reduce the net figure, and they vary between brokers.
The mistake people make here
The common mistake is to move the stop further away when price comes close to it, while leaving the target where it was. That changes the ratio after the trade is open, and it turns a planned R20.00 loss into something larger. The arithmetic only works if the stop and target are set before entry and left alone. If the reason for the trade has gone, close it at the stop you chose, not at a new one.Check yourself
With a 1:2 ratio, 20 pips stop and 40 pips target on 0.10 lots, what is the net result over 10 trades if 4 win and 6 lose, before costs?
Wins: 4 × 40 pips = 160 pips. Losses: 6 × 20 pips = 120 pips. Net: 160 − 120 = 40 pips. At about R1.00 per pip, that is +R40.00 before costs.
If the same 10 trades had a 1:1 ratio, with 20 pips stop and 20 pips target, what would the net be with 4 wins and 6 losses?
Wins: 4 × 20 pips = 80 pips. Losses: 6 × 20 pips = 120 pips. Net: 80 − 120 = −40 pips, or about −R40.00 before costs.