Investors use risk/reward ratios to compare an investment’s expected return to the risk taken to capture those returns. It’s calculated by comparing what the investor stands to lose to the amount by which the investor expects to profit when she closes the position.Say an investor buys 100 shares of XYZ Company at $20 each and places a stop-loss order on her position at $15. The stop-loss order protects her from losing more than $5 per share. Risk/reward ratios cannot be calculated without a stop-loss order. Meanwhile, the investor expects XYZ’s shares to climb to $30. The investor has risked $5 per share to earn an expected $10 per. Her risk/reward ratio is 1:2. Every trade entails some degree of risk. Riskier investments require a greater return to make the investment worthwhile. While optimal risk/reward ratios vary by trading strategies, ratios that are 1:1 mean the risk equals the potential return. Such trades are not as favorable as those that are 1:3, where the expected return is three times the risk. Knowing the risk/reward ratio on any trade protects investors and their accounts. The risk/reward ratio is an effective risk management tool and should be used before entering into any position.