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What is a Risk/Reward Ratio?

Many investors use a risk/reward ratio to compare the expected returns of an investment with the amount of risk undertaken to capture these returns.


For example: A trader purchases 100 shares of XYZ Company at Rs.100 and places a stop-loss order at Rs.75 to ensure that losses will not exceed Rs.2500. Also assume that this trader believes that the price of XYZ will reach Rs.150 in the next few months. In this case, the trader is willing to risk Rs.25 per share to make an expected return of Rs.50 per share after closing the position. Since the trader stands to make double the amount that she has risked, she would be said to have a 1:2 risk/reward ratio on that particular trade. 

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