Risk/Reward Ratio

Risk/Reward Ratio is a ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns.

Risk/Reward Ratio

Risk/Reward Ratio is a ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns.

 


Explanation of Risk/Reward Ratio

The Risk/Reward Ratio is calculated by dividing the amount of profit the trader expects to have made when the position is closed (i.e. the reward) by the amount he or she stands to lose if price moves in the unexpected direction (i.e. the risk).

 If an investment is judged to entail risk, then the reward of said investment must be higher than the risk-free rate of return to such a degree that the investor is fully compensated for the extra risk taken. If the reward is not compensatory than the investment is judged to have a poor risk/reward ratio.


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