The risk/reward ratio shows the reward that can be earned by an investor, for each rupee they risk on an investment.
A lot of investors and analysts turn towards the risk/reward ratio to have a comparison between the expected returns of an investment with the measure of risk they should undertake to earn these rewards.
Think about the following example: an investment with a risk-reward ratio of 1:7 proposes that an investor is alright risking Rs. 1, for the possibility of gaining Rs. 7.
On the other hand, a risk/reward ratio of 1:3 implies that an investor should expect to invest $1, for the possibility of procuring $3 on his investment.
Traders frequently utilize this method to plan which trades to take, and the ratio calculation is done by dividing the amount a trader stands to lose if the price of a stock moves in an unexpected direction (the risk) by the profit the trader expects to have made when the trade is closed (the reward).
The risk/reward ratio is frequently utilized as a measure when trading single stocks.
The ideal risk/reward ratio varies widely among different trading strategies. Some experimentation techniques are normally required to figure out which ratio is best for a given trading strategy, and a lot of investors have a pre-specified risk/reward ratio for their investments.