Risk to reward ratios, also known as risk/reward ratios, are a quick way for investors to determine if the potential risk of an investment is worth the payout if things go well. While risk to reward ratios may be a helpful indicator of whether an investment is worth making, the actual ratio is based on what an investor believes will happen, so it is less than scientific. Good investors will use numerous pieces of data, including risk to reward ratios, before making a decision.
Determine the price that you are willing to pay for a stock or commodity. Multiply the number of items you will purchase by this price to get your initial investment total.
Figure out the stop loss target, which is the price that you will sell your investment for a loss, to prevent losing your entire investment. Then figure out the stop profit target, which is the price where you will sell the investment to collect your profit.
Multiply stop loss target by the number of items you purchased, and then subtract that from your initial investment. This will give you your loss. Multiple the stop profit target by the number of items, and subtract the initial investment from this number. This will give you your profit.
Divide your profit by the loss to get your risk to reward ratio. The ratio is usually recorded as the reward, followed by a colon, followed by the risk, such as 2:1. Divide both sides of the colon by the same number to reduce the fraction, making it easier to read.
Shawn McClain has spent over 15 years as a journalist covering technology, business, culture and the arts. He has published numerous articles in both national and local publications, and online at various websites. He is currently pursuing his master's degree in journalism at Clarion University.