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The risk-reward ratio compares the potential loss of a trade to its potential profit. It is calculated by dividing the distance to the stop loss by the distance to the take profit. A 1:2 ratio means you risk $1 to potentially make $2. A favorable risk-reward ratio allows a strategy to be profitable even with a win rate below 50%.
You buy EUR/USD at 1.1050 with a stop loss at 1.1020 (30 pips risk) and a take profit at 1.1110 (60 pips reward). Your risk-reward ratio is 1:2. At 1:2, a strategy breaks even before costs at a win rate of about 33%, so a 40% win rate would be profitable before spreads, commissions and swaps.
