Reward to Risk Calculation

Calculate Risk/Reward by dividing profit (reward) by your maximum risk. You may notice the equation of often written incorrectly as I did here. Investors often speak of Risk/Reward to Risk to Reward, but they actually mean the opposite: Reward to Risk or Reward/Risk. It’s the same as Profit/Loss or P&L. What we really mean is how much Reward is achieved for the Risk taken, so it’s Reward/Risk.

Reward to Risk Ratio

If we risk $1 to earn $2, that’s a Reward/Risk or Reward to Risk ratio of 2:1. The Reward was twice as much as the risk. This could be used in different ways to illustrate Reward to Risk.

Before an investment position is entered we can Calculate the Reward to Risk potential.
- If we enter a position at $50 per share and expect it could trend to $60, that’s a $10 increase or 20%. That may not seem like a lot and it isn’t if you are risking all of the investment. But, if you limit the loss to $5 and predetermine that we’ll exit at $45, then the Reward to Risk is much more of an edge.
After an investment position is closed (sold) we can Calculate the Risk to Reward achieved.If we entered a position at $50 per share and it trended to $60 and we sold it, that’s a $10 increase or 20% realized profit. A gain is not realized as a profit until it is sold. Simply being “up” in a position doesn’t mean you really have a profit.

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