Help Center

Home

Financial Terms and Glossary

Risk vs reward ratio

Risk vs Reward Ratio

The risk vs reward ratio is a financial metric used to evaluate the potential return of an investment relative to its risk. It is calculated by dividing the potential profit by the potential loss of a trade or investment. A lower ratio indicates that the investment offers a higher potential return for a given level of risk, while a higher ratio suggests that the risk outweighs the potential reward. Investors use this ratio to determine whether the potential benefits of an investment justify the risks.

Example

An investment with a potential profit of $200 and a potential loss of $100 has a risk vs reward ratio of 1:2, meaning the investor stands to gain twice as much as they could lose.

Key points

• A metric used to evaluate the potential return of an investment relative to its risk.

• Calculated by dividing the potential profit by the potential loss.

• Helps investors assess whether the potential reward justifies the risk.

Quick Answers to Curious Questions

Why is the risk vs reward ratio important for investment decisions?

It helps investors determine whether the potential return is worth the risk, guiding them toward investments with favorable risk-reward profiles.

What does a 1:3 risk vs reward ratio mean?

It means that for every $1 of potential loss, the investor could gain $3, offering a favorable balance between risk and reward.

How can investors improve their risk vs reward ratio?

By selecting investments with higher potential returns and managing risks through diversification, hedging, or stop-loss strategies.

scroll top