riskreward

Risk-reward, commonly referred to as the risk-reward ratio, is a framework for comparing the potential downside of a decision with its potential upside. It is used to assess whether an opportunity justifies the risk and to guide capital allocation across trades, investments, or projects. The concept is widely applied in finance and business decision making as a concise way to summarize the trade-off between risk and return.

In trading and investing, the ratio is typically calculated as potential reward divided by potential risk. For example, entering a position with a stop loss 10 units below the entry and a take profit 20 units above yields a 20:10, or 2:1, risk-reward. Lower ratios are generally more favorable, but actual profitability also depends on the probability of a successful outcome.

Risk-reward interacts with probability and time horizon. The expected value EV is computed as the probability of a win times the reward minus the probability of a loss times the risk. The ratio does not guarantee success and should be considered alongside risk tolerance, diversification, and other performance metrics such as the Sharpe ratio or Sortino ratio.

Limitations and cautions: high upside opportunities with low probability can still yield negative expected value; fixed stop-loss and target levels may not reflect real market dynamics, and costs such as slippage and fees can erode results. Used prudently, risk-reward helps compare opportunities and structure risk management plans rather than serve as a sole decision rule.