What is the Risk Reward Ratio?
The Risk Reward Ratio (RRR) is essentially the ratio an investor takes into account regarding balancing the returns and risk they may endure during particular investments.
Undeniably, contemplating risks is as important as considering profit. Good investments always take risks into account as a priority, but why so? Well, if not taken into concern, risks like unpredicted price volatility can hinder investment plans and without any form of risk management, investments can be greatly damaged.
As an exemplification, in the event that an exchange platform faces issues after an investor’s recent coin purchase, coinciding with the same period the price starts falling, investors without back-up plans or cut loss orders in place may take losses and further risks as a result.
However, if the matter of risks were taken into account ahead of possible profitable margins, investment strategies or stop loss orders would be planned in place prior to any possible unpredicted price movements. By introducing Risk Reward Ratios, investors would be able to deeply analyze whether or not certain investments are worth the risk.
The surprisingly uncomplicated calculation is as follows:
Reward = take profit price - purchase price
Risk = purchase price - cut loss price
Risk Reward Ratio = Risk/Reward
If BTC was bought at a current standing price of 10,000 baht,
The projected take profit price would be 15,000 baht (25,000 - 10,000) and the reward would be 15,000 baht.
The cut loss would be laid under the support line. If BTC’s price falls below 9,500 baht (10,000 - 9,500), the risk would be 5,000 baht. Therefore, the Risk Reward Ratio would be 5,000 / 15,000 = 0.33
When contemplating on the risks and rewards of certain investments, an easy observation that does not require complex calculation is the examination of the reward worth that exceeds risks. From this point, the risk can be divided by the reward returns, resulting in the RRR. Note that the closer it is to zero, the better, as it can help determine whether or not the investment is worth the risk.
Also, in reality, the ratio can be set differently according to the situation at hand. Sometimes, the risk would be divided by the rewards rate and sometimes, the other way around.
It is worth noting that investments are saturated with raisks. It is impossible to be certain of any future predictions, therefore, it is integral to conduct plans and risk and reward contemplation through the RRR to ensure that investments do not cause harmful damage to investors and funds.