Position sizing: how to calculate trade sizeTwo traders take the same trade, at the same price, with the same stop. One loses 1% of their account and the other loses 10%. The only difference between them is a number they chose before entering.Risk-to-reward, win rate and expectancy
A 1:3 ratio is not better than 1:1. It is a different bet, requiring a different hit rate, and the ratio on its own cannot tell you whether a strategy makes money.
Risk $100 to make $200 and you have a 1:2 trade. The calculation is trivial and the conclusion most people draw from it is wrong.
The advice that follows is usually "only take trades of 1:2 or better", which sounds like discipline and is really an incomplete sentence. A ratio describes the size of the two outcomes. It says nothing about how often each one happens - and a target twice as far away is generally reached less often.
What each ratio actually demands of you
Every ratio implies a hit rate you must beat simply to break even. This is the number the ratio is really telling you, and it is rarely the one quoted.
- 50%to break even at 1:1Win half your trades and you are level, before costs.
- 33%at 1:2You can be wrong twice as often as you are right.
- 25%at 1:3Three losses per win is break even.
Break-even win rate = risk ÷ (risk + reward). Every figure here ignores spread, commission and slippage, all of which raise the rate you actually need.
The full relationship, for reference.
| Risk-to-reward | Break-even win rate |
|---|---|
| 1:0.5 | 66.7% |
| 1:1 | 50.0% |
| 1:1.5 | 40.0% |
| 1:2 | 33.3% |
| 1:2.5 | 28.6% |
| 1:3 | 25.0% |
| 1:4 | 20.0% |
| 1:5 | 16.7% |
Before trading costs.
Two strategies with nothing in common, both profitable
This is the argument against ratio rules. Neither of these is the correct approach; both work, in opposite ways, and a trader running one while judging themselves by the other's standards will abandon a perfectly good method.
Rare, large winners
Wins 30% of the time, averaging 3R per winner against 1R losses. Seven losses and three wins across ten trades leaves +$200 on a $100 risk unit.
Feels like failure most of the time. Long losing runs are normal and expected, which makes it psychologically difficult and makes position sizing non-negotiable.
Typical of trend-following, where the year is made by a handful of trades.
Frequent, small winners
Wins 80% of the time, averaging 0.5R per winner against 1R losses. Eighty wins and twenty losses across a hundred trades leaves +$2,000 on the same unit.
Feels good almost every day, and the occasional loss is larger than several wins combined. The risk is that one undisciplined loss erases a month.
Typical of mean-reversion. A 1:0.5 ratio looks indefensible on paper and is fine at that hit rate.
Both are before costs. Strategy B places far more trades, so costs damage it considerably more.
The figure that actually decides it
Expectancy combines both halves: how often you win and how much you win when you do. It gives the average result per trade over a large sample, which is the only figure that answers the question a ratio pretends to.
Expectancy of the 30% win-rate strategy
- Average winner30% of trades+$300
- Contribution from winners0.30 × $300+$90
- Average loser70% of trades−$100
- Contribution from losers0.70 × $100−$70
Expectancy per trade+$20Positive, while losing seven trades in ten. The same calculation on the 80% strategy also returns +$20, by an entirely different route.
R multiples, and why they are worth the habit
R is simply the amount risked on a trade. Losing that amount is −1R, making three times it is +3R. Expressing results this way lets you compare a gold trade against a EUR/USD trade against a share, regardless of position size, and it is how any serious record of results is kept.
Five trades of −1R, +2R, −1R, +3R, −1R sum to +2R. Whether that was $200 or $2,000 depends on your position sizing, and the risk-adjusted performance is identical either way.
Why a bigger target is not a free upgrade
Buy at $100 with a stop at $95. A 1:1 target is $105, 1:2 is $110, 1:10 is $150. On paper the last is spectacular. In practice the market must travel fifty dollars before falling five, and that is a materially less likely sequence than reaching $105 first.
Stretching a target does not improve a strategy. It trades hit rate for size, and whether that is a good trade depends entirely on where the strategy's edge comes from.
The same applies in reverse to the stop. Moving it from $95 to $98 turns 1:2 into 1:5 on the spreadsheet while making it far easier for ordinary noise to close the trade. A ratio should be an output of a coherent setup, not a number manufactured by relocating the exit.
Costs move the whole table
Every break-even figure above ignores spread, commission and slippage. Add them and each one rises.
How much depends on scale. A one-pip spread against a 100-pip target is a 1% drag; against a 10-pip target it is 10%, and a nominally 1:1 strategy is quietly running at something worse. This is why identical ratios can be viable for a swing trader and hopeless for a scalper, and why execution quality is a strategy question rather than a technicality.
Ten trades tell you almost nothing
A strategy that wins eight of its first ten has an observed win rate of 80% and an unknown real one. Small samples are dominated by chance, and the temptation is to abandon a sound method after a normal losing run or to scale up a lucky one.
A useful assessment needs enough trades to see the win rate, the average winner, the average loser, the longest losing streak and the deepest drawdown. That is a matter of dozens rather than a handful.
Questions people ask about risk-to-reward
Is 1:2 a good risk-to-reward ratio?
It is a common one. Whether it is good depends on whether your strategy reaches that target more than a third of the time, which is what 1:2 requires before costs.
Is 1:3 better than 1:2?
Not automatically. It needs a lower hit rate to break even and it is generally reached less often. Which is better is an empirical question about your actual results.
Can a 30% win rate be profitable?
Yes, if winners are large enough relative to losers. At 1:3 the break-even rate is 25%, so 30% is profitable before costs.
Is a high win rate better?
Not on its own. A strategy winning 90% of the time loses money if the occasional loss is bigger than ten wins combined.
What is 1R?
The amount risked on a trade. If you are risking $100, then 1R is $100, a $300 profit is +3R and a full loss is −1R.
Does position size change the ratio?
No. It changes both the potential loss and the potential gain proportionally, so the ratio is unchanged. It changes what those outcomes do to your account.
Does leverage change the ratio?
No. Leverage decides the margin needed to hold the position. The relationship between entry, stop and target is unaffected.
Do spreads affect it?
Yes, and disproportionately for strategies with small targets. Costs are subtracted from every winner and added to every loser, which worsens the effective ratio in both directions.
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