Risk/Reward Ratio

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 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).

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 2:1 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.


Investment dictionary. . 2012.

Игры ⚽ Нужна курсовая?

Look at other dictionaries:

  • risk-reward ratio — Relationship of substantial reward corresponding to the amount of risk taken; mathematically represented by dividing the expected return by the standard deviation. Bloomberg Financial Dictionary …   Financial and business terms

  • Risk adjusted return on capital — (RAROC) is a risk based profitability measurement framework for analysing risk adjusted financial performance and providing a consistent view of profitability across businesses. The concept was developed by Bankers Trust in the late 1970s. Note,… …   Wikipedia

  • Win/Loss Ratio — A ratio of the total number of winning trades to the number of losing trades. It does not take into account how much was won or lost simply if they were winners or losers. Win/Loss Ratio = Winning Trades : Losing Trades The win/loss ratio is also …   Investment dictionary

  • Sharpe ratio — The Sharpe ratio or Sharpe index or Sharpe measure or reward to variability ratio is a measure of the excess return (or risk premium) per unit of deviation in an investment asset or a trading strategy, typically referred to as risk (and is a… …   Wikipedia

  • Sterling Ratio — A ratio used mainly in the context of hedge funds. This risk reward measure determines which hedge funds have the highest returns while enduring the least amount of volatility. The formula is as follows: This formula uses the average for risk… …   Investment dictionary

  • Modigliani risk-adjusted performance — or M2 or M2 or Modigliani–Modigliani measure or RAP is a measure of the risk adjusted returns of some investment portfolio. It measures the returns of the portfolio, adjusted for the deviation of the portfolio (typically referred to as the risk) …   Wikipedia

  • Treynor ratio — The Treynor ratio is a measurement of the returns earned in excess of that which could have been earned on a riskless investment (i.e. Treasury Bill) (per each unit of market risk assumed).The Treynor ratio (sometimes called reward to volatility… …   Wikipedia

  • Treynor Ratio — A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless investment per each unit of market risk. The Treynor ratio is calculated as: (Average Return of the Portfolio Average… …   Investment dictionary

  • Sharpe ratio — A measure of a portfolio s excess return relative to the total variability of the portfolio. Related: treynor index A ratio of reward to variability developed by William F. Sharpe to measure the performance of mutual funds without regard to their …   Financial and business terms

  • Sharpe-Ratio — Die Sharpe Ratio, auch Reward to Variability Ratio genannt, ist eine Kennzahl und betrachtet die Überrendite, also die Rendite einer Geldanlage, soweit sie den risikofreien Zinssatz übersteigt, in Abhängigkeit vom Risiko. Namensgeber ist William… …   Deutsch Wikipedia

Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”