Risk reward ratio definition
The risk-to-reward ratio evaluates the level of potential downside to an investment, compared to the potential gains.
While different strategies form different ratios, the general rule is a risk-to-reward ratio of over 1.0 means the possible risk is greater than the possible reward, and anything below 1.0 means the possible profits are greater than the potential risk.
Stop-loss orders and derivatives allow investors to manage the risk-to-reward ratio. Using a stop-loss order, the risk is calculated to be the difference between the price paid for the investment versus the stop-loss order. This figure is then compared to the profit target set by the investor, calculated by the difference between the price paid for the investment and the anticipated profit.