Prerequisite: Size the risk before the position
Learning objective
Calculate a planned ratio and explain why it does not prove positive expectancy.
A planned reward-to-risk ratio compares a positive target gain with a positive stop loss, using consistent units. For a long setup the stop must be below entry and target above; for a short setup the order is reversed. This describes a scenario, not its likelihood.
In a simplified model where every win is W, every loss is L and there are no costs or other outcomes, break-even win rate is L / (W + L). Real partial exits, variable losses and costs change the calculation. A chosen target is not the average realised win.
Estimate expectancy from representative realised outcomes: win frequency × average net win minus loss frequency × average net loss, including zero outcomes in the frequencies. A small or selected sample can mislead. Track both the planned ratio and the actual outcome in R, where one R is the stated initial risk.
Worked example
Hypothetical long entry 100, stop 98, target 104: risk distance 2 and reward distance 4, so ratio 2. In the simplified no-cost model the break-even win rate is 2 / (4 + 2) = 33.33%. This does not forecast a win rate.
Common mistakes
A large target alone does not create an edge. Gaps can make a loss larger than one R.
Practice
Repeat the ratio for a short scenario: entry 100, stop 103, target 94. Explain which model assumptions would fail with a partial exit.
Reward-to-risk practice
Compare price distances only. Break-even rate uses constant wins and losses, no costs, no partial exits and no other outcomes; it is not a predicted win rate.