Risk and reward
What you learn in 3 minutesThis lesson shows what the ratio between your stop and your target does to the number of trades you need to win just to break even, and what that costs in naira. If your stop is 20 pips away and your target is 40 pips away, the ratio is 1 to 2. The arithmetic of that ratio is fixed; the ratio you can actually get in the market is not, because it depends on where price is willing to go.
A 1 to 2 ratio at 40 per cent wins
| Step | Amount | Note |
|---|---|---|
| Entry price | 1.0850 | the price where the trade is opened on EUR/USD |
| Stop distance | 20 pips | the stop sits 20 pips from entry |
| Target distance | 40 pips | the target sits 40 pips from entry, so the ratio is 1 to 2 |
| Value of one pip on one standard lot | 10 units of the quote currency | 100,000 x 0.0001; converted to naira at the current rate |
| Risk per trade on 0.10 lots | ₦21,700 | 20 pips x 0.10 lots x 10 units = 20 units of the quote currency, converted at ₦1,085 per unit |
| Reward per winning trade on 0.10 lots | ₦43,400 | 40 pips x 0.10 lots x 10 units = 40 units of the quote currency, at the same rate |
| Result over 10 trades at 40 per cent wins | ₦43,400 | 4 wins x ₦43,400 = ₦173,600; 6 losses x ₦21,700 = ₦130,200; difference ₦43,400 |
The broker may round the pip value, charge a spread when you enter and exit, and apply a commission or swap. Those costs vary between brokers and reduce the figures above.
The mistake people make here
The common mistake is to fix the target at some round number and let the stop fall wherever it lands, so the ratio becomes 1 to 1 or worse without anyone deciding it. Then a 40 per cent win rate loses money, and the account shrinks even though the reader feels they are winning often enough. Instead, write the stop distance first, based on where the trade idea is wrong, and only then check whether a target twice that distance is realistic. If it is not, the trade is not worth taking at that size.Check yourself
If the stop is 25 pips and the target is 50 pips, what is the ratio, and how many naira does one loss cost on 0.20 lots at ₦1,085 per unit of the quote currency?
The ratio is 1 to 2. One pip on 0.20 lots is 2 units of the quote currency, so 25 pips is 50 units. At ₦1,085 per unit that is ₦54,250.
At a 1 to 2 ratio, what win rate is needed just to break even before costs?
One win pays two units and one loss costs one unit. To break even, the wins must cover the losses: with 1 win in every 3 trades, 2 units gained equals 2 units lost. That is about 33 per cent, before spreads and commissions.