What the ratio compares
The risk-reward ratio compares the amount you risk on a trade to the amount you aim to make. If you risk 20 pips to potentially gain 40, that is a 1:2 risk-reward ratio — your target is twice your risk.
The ratio is defined by where you place your stop-loss and your take-profit relative to your entry. It is one of the few things you fully control before a trade begins, which makes it a powerful lever compared with the price movement itself, which you cannot control.
Why win rate alone deceives
Beginners often chase a high win rate, but win rate means nothing without risk-reward. You can win 70% of trades and still lose money if your losers are much bigger than your winners. Conversely, you can win only 40% of the time and be profitable if your winners are twice the size of your losers.
A worked example: with a 1:2 ratio, risking €100 to make €200, winning just 40 of 100 trades yields 40 wins of €200 (€8,000) against 60 losses of €100 (€6,000) — a €2,000 profit despite losing most trades. The size of outcomes matters as much as their frequency.
Using it honestly
A good ratio on paper is worthless if it is unrealistic. Setting a far-away take-profit to boast a 1:5 ratio does nothing if price never reaches it. The target must be plausible given how the instrument actually moves, or the ratio is fiction.
The practical value of thinking in risk-reward is that it forces you to define your exit before entering and to skip trades where the potential reward does not justify the risk. Over many trades, patiently taking only favourable ratios is a genuine edge — but only if you honour the stops.