Risk/reward is a common financial term, but its meaning can be confusing. Simply put, investing requires a degree of risk, and the bigger that risk, the higher the gain should be.For example, Company XYZ’s stock is trading at \$25 a share, down from a recent high of \$29. An investor thinks it’ll go back up soon. She plans to invest \$500 into 20 shares, then cash in when the stock returns to \$29. The investor’s research needs to include the risk/reward ratio. Risk/reward is an objective calculation that provides no indication of whether the investment will pay off. To calculate it, divide the net profit by the price of maximum risk. If XYZ’s stock goes up \$4 per share, the net profit after selling at \$29 would be \$80. The investor paid \$500 for it, making the risk/reward ratio 80 divided by 500, or .16, or .16-to-1. Most sensible investors will not let their initial \$500 fall to zero. They’d set a stop-loss at a price that would limit their risk, say at \$20 per share. The new ratio uses the same \$80 profit, but the maximum loss is \$100, or a \$5 maximum loss per share multiplied by 20 shares. That’s a ratio of .8, or .8-to-1. A risk/reward ratio of 2-to-1 is what many investors demand before they’ll consider an investment. Most want it closer to 4-to-1. It’s up to the investor to determine an acceptable ratio, but it’s always best to be more conservative with risk than aggressive with reward.