Risk Reward Ratio In Trading

How To Get Hold Of The Risk Factor And Reward Ratio?

The risk-to-reward ratio is a ratio investors use to compare the probable returns out of a particular investment to the amount of risk they take to get these returns. The balance has an arithmetical formula.

Calculation:

Divide the risk - the amount the investor will lose if the price moves in a negative direction by the reward - the profit the investor can make when the position is closed. The traders should not have a 1:1 risk-to-reward ratio, as it indicates the potential loss over the investment will be much higher than any predictable profit.

A reasonable risk-to-reward ratio is 1:2, which indicates the profit or reward is higher than the loss. The trader has assured a substantial break-even profit margin when the trading suffers any loss.

Let us look into the illustration: A trader purchases 100 shares for XYZ Company for Rs.20 and fixes a limit of R.15 stop-loss to make sure their loss will not go beyond Rs.500.

Let us presume that the trader anticipates the price of XYZ to reach Rs.30 in a few months. This indicates that the trader is enthusiastic about going under risk of Rs.5 for every share to make an expected return go Rs.10 after closing the deal.

Since the trader is likely to make a profit double the risk, the risk-to-reward ratio is 1:2 in this trading. The trial and error method is best. The trial and error method would be the best option to determine the best-suited ratio for every individual trading.

Conclusion:

The risk-to-reward ratio calculation offers the traders a rough idea about the likely outcome of the trading done, providing them with a chance to work on plan B if a loss is incurred. It is relevant to the share market, Indian stock market, national stock exchange, equity market, or the stock trading scenario. Permutation, combination, and specialist help will get good returns on investments.