LeoGlossary: Risk/Reward Ratio
The Risk/Reward Ratio is a tool that investors and trades use before entering a position. This is a balancing of the reward that one can receive while weighing it against the risk. It is a way that investors judge the expected returns as compared to the potential loss.
In other words, what type of risk is taken on to achieve said returns.
This is expressed in a ratio such as 1:4 or 1:10. What this means is that one is going to risk 1 unit of a currency (we will use the US dollar) in order to gain multiple units in return. Thus, a 1:4 is risking $1 for a potential return of $4.
Obviously, we can use this to compare two investment or trade options. If one asset carries a risk/reward of 1:4 whereas the other is 1:10, we can see how the latter can benefit us greater.
With trading, this ratio is determined by dividing the amount that potentially could be lost if the trade goes against the individual by the profit earned if the trade is closed at the expected point.
General:
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