Investopedia

Risk/Reward Ratio

Dictionary Says

Definition of 'Risk/Reward Ratio'

A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. This ratio is calculated mathematically by dividing the amount he or she stands to lose if the price moves in the unexpected direction (i.e. the risk) by the amount of profit the trader expects to have made when the position is closed (i.e. the reward).
Investopedia Says

Investopedia explains 'Risk/Reward Ratio'

Let's say a trader purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that her losses will not exceed $500. Let's also assume that this trader believes that the price of XYZ will reach $30 in the next few months. In this case, the trader is willing to risk $5 per share to make an expected return of $10 per share after closing her position. Since the trader stands to make double the amount that she has risked, she would be said to have a 1:2 risk/reward ratio on that particular trade. The optimal risk/reward ratio differs widely among trading strategies. Some trial and error is usually required to determine which ratio is best for a given trading strategy.

Articles Of Interest

  1. Find The Highest Returns With The Sharpe Ratio

    Learn how to follow the efficient frontier to increase your chances of successful investing.
  2. Why Stocks Outperform Bonds

    Why have stocks historically produced higher returns than bonds? It's all a matter of risk.
  3. Minimize Risk With The Long Collar

    Think your favorite stock is on the way down? This simple option-trading strategy can help you manage your risks without selling the stock.
  4. Equity Premiums: Looking Back And Looking Ahead

    If stocks become less profitable in the future, you may have to change your investment strategy.
  5. Behavioral Bias - Cognitive Vs. Emotional Bias In Investing

    We all have biases. The key to better investing is to identify those biases and create rules to minimize their effect.
  6. Why Your Pension Plan Has Sovereign Debt In It

    One type of security pensions tend to invest in is sovereign debt, or debt issued by a government.
  7. Trading Is Timing

    Learn how to make gains even if you don't get in at the right time.
  8. How To Profit From Risk

    CDs may look safe and attractive but considering most pay a rate that is less than the rate of inflation seniors today risk actually losing money with CDs. We need to be our own money managers ...
  9. Investing In REITs Instead Of Property

    Learn why this one particular REIT is a better investment than holding physical property in your retirement portfolio.
  10. Examples Of Asset/Liability Management

    In its simplest form, asset/liability management entails managing assets and cash inflows to satisfy various obligations; however, it's rarely that simple.
comments powered by Disqus
Marketplace
Hot Definitions
  1. Glocalization

    A combination of the words "globalization" and "localization" used to describe a product or service that is developed and distributed globally, but is also fashioned to accommodate the user or consumer in a local market.
  2. Disaster Loss

    A special type of tax-deductible loss, similar to a casualty loss, where a loss has been incurred by taxpayers who reside in an area that has been designated as a federal disaster area by the President.
  3. Fool In The Shower

    The notion that changes or policies designed to alter the course of the economy should be done slowly, rather than all at once.
  4. Pattern Day Trader

    An SEC designation for traders who trade the same security four or more times per day (buys and sells) over a five-day period, and for whom same-day trades make up at least 6% of their activity for that period.
  5. Cost-Push Inflation

    A phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials.
  6. Happiness Economics

    The formal academic study of the relationship between individual satisfaction and economic issues, such as employment and wealth.
Trading Center
Array ( )
taggroups(for debug only):
Array ( [0] => Investing-Basics [1] => SEG (Investors) [2] => Investing ) time:10ms