#RiskRewardRatio
Part:
What is the risk-to-reward ratio?
The risk-to-reward ratio is a financial metric used to compare the potential profit from an investment (reward) against the potential loss (risk). This metric is widely used by traders and investors to assess the attractiveness of a specific trade or investment.
How to calculate the risk-to-reward ratio
Formula:
Risk-to-reward ratio = (Entry Price - Stop-Loss Price) / (Target Price - Entry Price)
• Entry Price: the price at which the investment is purchased.
• Stop-Loss Price: the price set to limit losses.
• Target Price: the expected price for selling to realize a profit.
Example:
If a stock is purchased at $100, a stop-loss is set at $95, and the target is $110:
Risk = $5, Reward = $10, so the risk-to-reward ratio = 5/10 = 0.5
The lower this ratio, the greater the expected reward compared to the risk, which is considered more desirable for investors.
How the risk-to-reward ratio works
• This ratio helps determine whether the trade is worth executing.
• Many traders aim for a ratio of 1:2 or less (risking one dollar to gain two dollars).
• This metric does not guarantee success, but it is used as a tool for making informed decisions and achieving long-term stability.
