Risk and reward

A stop is the price where you accept the trade is wrong. A target is the price where you take the profit. Most beginners choose the target first because a profit feels like the point of trading. That order is backwards. The stop comes from the chart, because the chart shows where the price would have to go for your reason to be invalid. On EUR/USD at 1.0850, if you buy because a support zone held, the stop belongs just below that zone, not at a round number that happens to suit your account.

Once the stop distance is fixed, the target distance is a question about the market, not about your hopes. Ask whether the price can travel twice the stop distance before it travels the stop distance. That depends on how far the nearest opposing level sits. If the next resistance is only 15 pips away and your stop is 25 pips, a 50-pip target is not realistic, however much you want it. You do not have to take that trade. Waiting is a decision, and it costs nothing.

The ratio is simply target distance divided by stop distance. A 25-pip stop and a 50-pip target give 1 to 2. A 25-pip stop and a 25-pip target give 1 to 1. The ratio is not a quality score. It is a statement about how often you must be right to avoid losing money. That number is arithmetic, and it does not care how you feel about the trade.

The break-even hit rate is the share of trades you must win for the wins to cancel the losses. With a 1 to 1 ratio, one win pays exactly one loss, so you must win more than half of your trades to finish ahead. Exactly half leaves you at zero before costs. With a 1 to 2 ratio, one win pays two losses, so you need to win only one trade in three to break even. The arithmetic is fixed. It does not change with the instrument or the account size.

The formula is one divided by one plus the ratio. For 1 to 2, that is 1 divided by 3, which is about 33 per cent. For 1 to 1, it is 1 divided by 2, which is 50 per cent. For 1 to 3, it is 1 divided by 4, which is 25 per cent. Notice that improving the ratio lowers the hit rate you need. It does not raise it. A wider target relative to the stop buys you room to be wrong more often.

The page's worked example used a 25-pip stop, a 50-pip target, a KSh 2,500 loss per losing trade, and 4 wins in 10 trades. Each win is KSh 5,000, so four wins give KSh 20,000. Six losses give 6 times KSh 2,500, which is KSh 15,000. The net is KSh 5,000. That result came from a 40 per cent hit rate, which is above the 33 per cent the ratio demands. A 30 per cent hit rate would have produced a loss.

The ratio you can get is not the ratio you choose. It is set by where the price levels sit on the chart in front of you. If your stop must be 30 pips away because the structure is there, and the next level that could stop a move in your favour is 40 pips away, the market offers roughly 1 to 1.3. You can still take it, but you now know you must win more than about 43 per cent of such trades to break even. That is a different trade from the one a video promised.

Broker costs change the required hit rate. The spread on EUR/USD and any commission are paid on every trade, win or lose. A 1 to 2 ratio that breaks even at 33 per cent before costs needs a higher share once costs are subtracted from each win and added to each loss. The exact effect varies between brokers and changes through the day, so check the costs your own account shows rather than assuming a number.

The conversion from pips to shillings also varies. One pip on one standard lot of EUR/USD is 10 units of the quote currency, which is US dollars. Converting that to KSh uses the rate your broker shows, and that rate moves. Many brokers charge a spread or commission on top. The pip value is therefore not a fixed shilling figure. Work in pips for the ratio, and convert to KSh only when you size the position.