#RiskRewardRatio The Risk-Reward Ratio is a tool that investors and Traders use to compare the Potential profit of a trade or investment to the Potential risk involved.
This ratio helps to assess whether the expected profit of an investment is appropriate for the risk involved.
How is the Risk-Reward Ratio calculated?
Yes
* Potential Loss (Potential Loss/Risk): This is the amount an investor is willing to lose on a trade or investment. Typically, this is the difference between the entry point and the stop-loss order (if used).
* Potential Gain (Potential Gain/Reward): This is the expected profit an investor expects to make from a trade or investment. Typically, this is the difference between the entry point and the take-profit order (if used).
Example:
Suppose you buy a stock that is priced at Rs. 100. You place your stop-loss at Rs. 95 and your take-profit at Rs. 110.
* Potential loss = 100 - 95 = Rs. 5
* Potential profit = 110 - 100 = Rs. 10
Therefore, the risk reward ratio will be:
\text{Risk reward ratio} = \frac{5}{10} = 0.5 \text{ or } 1:2
This means that for every Rs. 1 potential loss, you expect to earn a potential profit of Rs. 2.
Importance of risk reward ratio:
* Making informed decisions: It helps investors and traders to assess whether it is worthwhile to enter a trade or not. A good risk-reward ratio indicates that the potential profit is greater than the potential loss.
* Risk management: This is an important part of risk management. By maintaining a proper risk-reward ratio, investors can effectively allocate their capital and avoid large losses.
* Long-term profitability: Choosing trades with a consistently favorable risk-reward ratio can be profitable in the long run, even if your win rate is low.
* Comparing different opportunities: The risk-reward ratio helps you compare different investment opportunities and choose the best one.
Ideal risk-reward ratio:
