What is the risk-reward ratio?
Key points
● The risk-return ratio is an indicator that investors measure the expected income and losses in investments and transactions.
● The risk-return ratio helps investors manage their trading risks and mindset.
● The risk-return ratio should be used in conjunction with other risk management ratios to measure the risk of a transaction more comprehensively.
Understand the risk-return ratio
The risk-return ratio, also known as the Rmax R ratio, is an indicator that compares the potential profit of a transaction with the potential loss. The risk-return ratio marks the expected return for every dollar of risk that investors invest.
Many investors use risk-return ratios to compare the expected return on an investment with the amount of risk they have to bear in order to achieve these returns.
Consider the following example: an investment with a return on risk of 1:7 shows that an investor is willing to take a risk of $1 in order to get a return of $7. Alternatively, the 1:3 risk-return ratio indicates that investors expect a return of $3 for every $1 invested.
In many cases, investors find that the ideal risk-to-return ratio for their investments is about 1:3, that is, for each additional unit of risk, they will get an expected return of 3 units. Investors can manage the risk-return ratio more directly by using derivatives such as stop-loss orders and put options.
The risk / return ratio is often used as a measure when trading individual stocks. The optimal risk-return ratio varies widely among different trading strategies. Investors usually need some trial and error methods to determine which ratio is most suitable for a given trading strategy.
The limitation of risk-return ratio
Although the risk-return ratio represents the pros and cons of a transaction, it doesn't tell you everything about the deal. It is often used in conjunction with other risk management indicators, such as the win / loss ratio and break-even. Investors should consider different kinds of indicators and technical indicators and make cautious investments.
