Understanding the reward risk ratio can help traders to make profitable investments. To calculate the reward risk ratio, the distance between the entry and stop loss must first be calculated.
For example, let’s say that this is fifty points. Next find the distance between the entry and your take profit. If the latter is one hundred points, then the reward risk ratio is 2:1 (because one hundred divided by fifty equals two).
How To Use the Reward Risk Ratio
When traders are developing a strategy to use on their trading platform of choice such as LegacyFX, the risk reward ratio should be factored into this plan for the best chance of profitability.
For example, if you know you have a win rate of approximately 50%, you should only seek trades that offer at least 1:5, 2:1 or higher if you want to accelerate your account growth and create a buffer against losses.
General Investment Risk
There will always be a level of risk when it comes to investments, and each different type of investment will carry its own individual risk.
Before making an investment, it is important to consider the level of risk you are willing to accept. For example, there is a risk when investing in high-yield bonds or individual stocks that the principle could be lost, or that a municipality bond won’t keep pace with inflation.
Similarly, the expensive fees associated with some mutual funds may make it difficult to make a return on them.
Investment Risk Profiles
Stocks are widely regarded as more likely to make a return for their investors. Since 1926, stocks have returned an average annual rate of 10%. However, the likelihood of a return could be harder to gauge when buying stocks in, for example, small or start-up companies.
Different types of bonds have different levels of risk attached; AAA rated bonds are considered to be the safest, while junk bonds have the highest level of associated risk — but also the greatest value return potential.
Mutual funds are managed by professional portfolio managers and are often used to hedge against risk from other investments in a portfolio.
For more information about common investment risks and how they can change with age, please take a look at the embedded PDF.
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