Risk-reward ratio
The ratio weighs the possible gain against the possible loss. Together with the win rate, it decides whether a strategy is viable at all.
If you can win two euros while risking one, your ratio is two to one. That means you're allowed to be wrong more often than right and still come out ahead.
An example: at two to one, a win rate just above 33 percent is enough to break even. At one to one, you need over 50 percent. At one to two, over 66 percent.
That's why asking about win rate alone is pointless. Someone with a ninety-percent win rate can still lose money if the one failure eats up all nine wins. That happens more often than people think.
It also matters that the ratio is set before you enter. Push the target up after the fact because things are going well, or push the stop down because they're going badly, and you no longer have a ratio at all.
The break-even win rate follows from p = 1 / (1 + risk-reward ratio). At a ratio of 3, p = 0.25; at 1, p = 0.5; at 0.5, p = 0.667. This relationship makes clear that win rate and ratio only carry meaning together.
In practice, a structural link exists between the two: distant price targets get hit less often, so a high ratio systematically comes paired with a lower win rate. Strategies can't be improved simply by raising the target without lowering the win rate.
Worth noting is the gap between the planned and the realized ratio. Taking profits early shortens the winning side, while losses can exceed the planned amount through slippage and gaps. The realized ratio therefore sits systematically below the planned one, which needs to be factored into any strategy evaluation.
Summary
- Win rate alone says nothing, only together with the ratio.
- The needed win rate is one divided by one plus the ratio.
- The realized ratio almost always sits below the planned one.
Did you get it?
What win rate does a three-to-one ratio need to break even?
25 percent, since 1 divided by 1 plus 3 gives 0.25.
Why doesn't a higher price target automatically improve a strategy?
Because more distant targets get hit less often. The win rate falls to match.
Why does the realized ratio fall below the planned one?
Because gains often get taken early, and losses can run larger through slippage and gaps.
Related
- When to stopStage 2
- FOMOStage 2
- Risk and return are linkedStage 0