Risk-reward ratio and expectancy

Risk-reward for one trade

The risk-reward ratio compares the amount you can lose if your stop is hit with the amount you aim to gain if your target is hit. Risking 50 pips to make 100 pips is a 1:2 ratio. The ratio says nothing about how likely each outcome is, which is why it is only half of the picture.

Expectancy with a worked example

Expectancy is the average amount you expect to make per trade over many trades. It combines win rate and payoff: expectancy = (win rate x average win) - (loss rate x average loss). Suppose 40 percent of your trades win, your average win is 300 dollars and your average loss is 150 dollars. Expectancy = (0.40 x 300) - (0.60 x 150) = 120 - 90 = 30 dollars per trade.

That number is an average over a sample, not a promise. A 40 percent win rate still produces losing streaks, and a small sample can look very different from the true figure. Costs must be included: if spreads and commissions average 10 dollars per trade, expectancy falls to 20 dollars.

Why a ladder changes the maths

A ladder closes many entries at a single average price, so its win size is usually small and frequent, while its loss can be large and rare. Expectancy can look positive in calm markets and turn sharply negative when a trend runs through the deepest rung. Always calculate expectancy from the full loss distribution, including the worst basket you can imagine, not only from recent results.

Key takeaways

• Risk-reward describes payoff; win rate describes frequency; expectancy combines them.
• Include every cost, and use a large enough sample before trusting the number.
• For a ladder, the rare deep loss matters more than the frequent small wins.