Risk and reward

The break-even win rate is the share of trades that must succeed for the gains to exactly cover the losses. It depends only on the ratio between the stop distance and the target distance. For a stop of 20 pips and a target of 40 pips, the ratio is 1 to 2. The break-even win rate is the stop distance divided by the sum of the stop and target distances. Here, 20 divided by 60 gives one third, or about 33.3 per cent. At that win rate, the net result is zero before costs.

If the ratio changes, the break-even win rate changes with it. A stop of 30 pips and a target of 30 pips gives a ratio of 1 to 1. The break-even win rate is 30 divided by 60, which is 50 per cent. A stop of 20 pips and a target of 60 pips gives a ratio of 1 to 3. The break-even win rate is 20 divided by 80, which is 25 per cent. The arithmetic is fixed: a wider target relative to the stop lowers the share of trades that must work.

This break-even figure is not a prediction. It is the point where the sum of wins equals the sum of losses. Actual results will differ because the win rate is not known in advance. The next section shows how to use this figure with a sample of past trades.

The ratio you can actually get is set by the levels the chart shows. To measure it, find a price where the market has repeatedly turned. That is a potential stop level. Then find the next level where the market has repeatedly stalled. That is a potential target level. The distance from entry to stop and from entry to target gives the ratio. If the stop is 18 pips away and the target is 42 pips away, the ratio is 18 to 42, which simplifies to 1 to 2.33. That ratio is not chosen; it is observed.

Price does not always travel the full distance to the target before returning to the stop. A ratio that looks attractive on paper may sit at a level price rarely reaches. For example, a target 60 pips away might be beyond a recent high that price has failed to break three times. In that case, the target is unlikely to be hit before the stop. The ratio on the order ticket is still 1 to 3, but the chance of reaching it is lower than the arithmetic alone suggests.

Because the available ratio varies with the chart, you cannot assume a favourable ratio will always appear. Some weeks, the distance to the next clear level is small, giving a ratio near 1 to 1. Other weeks, it is larger. The break-even win rate you need changes accordingly. The only honest approach is to measure the ratio from the levels in front of you and accept that it may be less favourable than you would like.

The hit rate is the share of past trades that reached their target before their stop. It can only be estimated from a record of closed trades. A record of 50 trades with 22 winners gives a hit rate of 44 per cent. That figure describes what happened, not what will happen. It is a starting point for comparison with the break-even win rate. If the break-even rate is 33.3 per cent and the past hit rate is 44 per cent, the past series would have been in front before costs.

A small sample can mislead. Ten trades with six winners give a hit rate of 60 per cent, but ten trades is too few to rely on. The same strategy over 100 trades might show 38 winners, a hit rate of 38 per cent. The difference between 60 per cent and 38 per cent is large, and it comes from chance. For a rough guide, treat fewer than 30 trades as a sketch, not a measurement. Even 100 trades can be unrepresentative if market conditions change.

Costs reduce the effective hit rate. The spread is paid on entry and exit, and commission or swap may apply. These costs are not part of the ratio but they affect the net result. If the break-even win rate is 33.3 per cent before costs, it will be higher after costs. The exact amount varies between brokers, so the only way to know your own break-even rate is to include the costs your broker charges.