Risk/Reward Ratio

A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. This ratio is calculated mathematically by dividing the amount of profit the trader expects to have made when the position is closed (i.e. the reward) by the amount he or she stands to lose if price moves in the unexpected direction (i.e. the risk).

Investopedia Says:
Let's say a trader purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that her losses will not exceed $500. Let's also assume that this trader believes that the price of XYZ will reach $30 in the next few months. In this case, the trader is willing to risk $5 per share to make an expected return of $10 per share after closing her position. Since the trader stands to make double the amount that she has risked, she would be said to have a 2:1 risk/reward ratio on that particular trade. The optimal risk/reward ratio differs widely among trading strategies. Some trial and error is usually required to determine which ratio is best for a given trading strategy.

Related Links:
Learn to combine this powerful tool with traditional technical tools for greater returns. Using Pivot Points In FX
Should you refinance your mortgage to purchase other assets? Learn how to weigh your risk. Mortgage Asset-Liability Management Made Easy
Find out about the various styles of this trading strategy. Scalping: Small Quick Profits Can Add Up
It's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself. Ten Steps to Building a Winning Trading Plan
This technical indicator is underused in the currency markets, but it can help you isolate profitable opportunities. Make Sharp Trades Using Andrew's Pitchfork
Learn how to follow the efficient frontier to better returns. Modern Portfolio Theory Stats Primer
Discover how this high-flying application can be used in forex trading. Ichimoku Cloud Filters Information Storm