How is the risk/reward ratio defined in investing?

• A. Risk divided by the potential reward (profit) when a position is closed.
• B. Reward divided by risk.
• C. Time divided by risk.
• D. Price divided by volume.

Answer: (A)

Think of the risk/reward ratio as how much you could lose versus how much you could gain on a trade. It’s found by dividing the amount at risk by the potential profit. For example, if you risk $100 to potentially make $300, the ratio is 100/300, or 0.33—often described as a 1:3 risk-to-reward. A smaller ratio means you’re risking less for each dollar of potential profit, which helps evaluate whether a trade is worth taking. The other ideas don’t fit because reward divided by risk is the reciprocal measure (reward-to-risk), and time/risk or price/volume aren’t about the profit relative to the possible loss.