#RiskRewardRatio The risk/reward ratio (Risk/Reward Ratio or R/R Ratio) is a fundamental tool used by traders and investors to assess the profit potential of a transaction relative to the risk of loss. It allows determining whether an investment opportunity is worth considering by comparing the potential gain with the maximum acceptable loss.

How to calculate the risk/reward ratio?

The risk/reward ratio is calculated by dividing the risk (the maximum potential loss) by the potential reward (the target profit).

Formula:

Risk/Reward Ratio = Risk / Reward

Where:

• Risk: The difference between the entry price (purchase price) and the stop loss level. This is the maximum loss you are willing to accept on this transaction.

• Reward: The difference between the target price (potential selling price) and the entry price. This is the profit you expect to make on this transaction.

Example:

• Purchase price of a stock: €100

• Stop loss level: €95 (risk of €5 per share)

• Target price: €115 (potential reward of €15 per share)

Risk/Reward Ratio = €5 / €15 = 1/3 or 0.33

Interpretation of the risk/reward ratio:

• Ratio less than 1: Indicates that the potential reward is greater than the risk. For example, a ratio of 1:2 means you are willing to risk €1 to potentially gain €2.

• Ratio equal to 1: Indicates that the potential reward is equal to the risk. For example, a ratio of 1:1 means you are willing to risk €1 to potentially gain €1.

• Ratio greater than 1: Indicates that the risk is greater than the potential reward. For example, a ratio of 2:1 means you are willing to risk €2 to potentially gain €1.