Direct answer
A worked example of Risk Reward Ratio (R:R) shows how to calculate the ratio from specific, stated assumptions. The core idea is simple: you compare the size of the potential loss (risk) to the size of the potential gain (reward) using the same units, such as price distance or position value distance. The calculation does not require live prices; it requires you to define entry, risk boundary (often a stop), and reward boundary (often a target).
Mechanism and definition
Risk Reward Ratio is commonly defined as:
R:R = (Reward) / (Risk)
To compute it transparently, you must decide what “risk” and “reward” mean in your scenario. Two common approaches are:
- Price-distance approach: Measure the horizontal distance from entry to the risk level and from entry to the reward level (for example, in pips).
- Value-change approach: Convert those distances into monetary terms using position size (for example, $ at the risk level and $ at the reward level).
These approaches can produce the same ratio if the conversion is consistent. The key requirement is that both the numerator and denominator use the same measurement basis.
Worked example with fully stated assumptions
Assume the following, purely as an illustrative scenario (no real quotes are used):
- You enter a trade at a hypothetical price level: Entry = 1.0000.
- Your assumed risk level is: Risk boundary (stop) = 0.9950.
- Your assumed reward level is: Reward boundary (target) = 1.0100.
- Assume you measure distance in price units (you could also express them in pips; the method is identical).
Now compute the distances:
- Risk distance = Entry − Risk boundary = 1.0000 − 0.9950 = 0.0050
- Reward distance = Reward boundary − Entry = 1.0100 − 1.0000 = 0.0100
Compute the ratio:
- R:R = Reward / Risk = 0.0100 / 0.0050 = 2.0
Interpretation (mechanical, not predictive): An R:R of 2.0 means the assumed reward distance is twice the assumed risk distance. This description is about the geometry of your chosen levels, not about what the market will do.
Evidence or example comparison (same ratio, different value scale)
You can verify the ratio under a different basis if you keep the conversion consistent.
Assume position sizing converts 0.0050 price units into $50 of potential loss, and 0.0100 price units into $100 of potential gain. Then:
- Reward = $100
- Risk = $50
- R:R = 100 / 50 = 2.0
The ratio matches because the value conversion preserves the relationship between the same underlying distances.
Relevant limitations and risks
At least one important limitation is that R:R is not a prediction; it is only a ratio derived from your stated levels.
Material failure modes include:
- Assumption mismatch: If your “risk” and “reward” are measured in different units (for example, reward in pips but risk in dollars), the ratio can become meaningless.
- Costs and execution effects: The realized outcome can differ from the planned geometry because of transaction costs, spreads, and execution quality. R:R computed from clean distances may not match net results.
- Level changes after entry: If entry, stop, or target levels move (manually or automatically), the effective R:R changes.
- Market path risk: Even with a favorable R:R, the path the price takes can still lead to losses. For example, price can reach the risk boundary before reaching the reward boundary.
Because outcomes depend on conditions that are not included in the ratio, historical patterns of R:R do not guarantee future results.
Verification and next question
To independently verify a Risk Reward Ratio calculation, check these items:
- Are entry, risk boundary, and reward boundary explicitly stated?
- Are risk and reward measured using the same basis (both distances in the same units, or both values in the same currency terms)?
- Is the arithmetic correct (reward divided by risk)?
A useful next question is: What exact definition of “risk” and “reward” are you using—price distance or monetary value—and do you include costs if you want net outcome comparisons?