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Risk Reward Calculator

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A Risk Reward Calculator is an essential tool used by traders and investors to measure the potential risks and rewards associated with their trading decisions. This calculator helps in determining whether the potential returns of a trade justify the risks involved. By using specific inputs like Entry Price, Stop Loss Price, and Take Profit Price, traders can make more informed decisions, aiming to maximize returns while minimizing losses.

Understanding the Risk Reward Calculator

The primary purpose of the Risk Reward Calculator is to calculate the risk-reward ratio of a potential trade. This ratio is crucial for traders because it can indicate whether a trade is worth taking. The calculator takes into account three main inputs:

  • Entry Price (EP): The price at which you plan to buy or sell a security.
  • Stop Loss Price (SLP): The price at which you will exit your position to minimize losses if the market moves unfavorably.
  • Take Profit Price (TPP): The price at which you will exit your position to capture the profit if the market moves favorably.

Using these inputs, the calculator computes the following:

  • Risk per Share: This is the potential loss per share (or unit), calculated by the difference between the Entry Price and the Stop Loss Price.
  • Reward per Share: This is the potential gain per share, calculated by the difference between the Take Profit Price and the Entry Price.
  • Risk-Reward Ratio: This ratio helps traders evaluate the potential reward for every dollar risked.

Formula and Calculation

Here’s how the calculator works, illustrated with simple formulas:

  • For a long position:
    • Risk per Share (R) = Entry Price – Stop Loss Price
    • Reward per Share (RR) = Take Profit Price – Entry Price
  • For a short position:
    • Risk per Share (R) = Stop Loss Price – Entry Price
    • Reward per Share (RR) = Entry Price – Take Profit Price
  • Risk-Reward Ratio (RRR) = Reward per Share / Risk per Share

Step-by-Step Example

Let’s consider a practical example to demonstrate how the Risk Reward Calculator is used:

  1. Entry Price (EP): $100
  2. Stop Loss Price (SLP): $95
  3. Take Profit Price (TPP): $110

Calculations:

  • Risk per Share: $100 – $95 = $5
  • Reward per Share: $110 – $100 = $10
  • Risk-Reward Ratio: $10 / $5 = 2

This means that for every dollar risked, the potential return is two dollars, indicating a risk-reward ratio of 2:1. This trade would be considered favorable because the potential reward doubles the risk.

Relevant Information Table

InputDescriptionExample Value
Entry PricePrice at which the trade is entered$100
Stop Loss PricePrice at which the trade is exited to limit losses$95
Take Profit PricePrice at which the trade is exited for a profit$110
Risk per ShareDifference between entry price and stop loss price$5
Reward per ShareDifference between take profit price and entry price$10
Risk-Reward RatioRatio of potential reward to risk2:1

Conclusion

The Risk Reward Calculator is an indispensable tool for traders who aim to make prudent and profitable trading decisions. By quantifying the risks and comparing them against the potential rewards, traders can better manage their portfolios and make choices that align with their risk tolerance and investment goals. This calculator not only assists in minimizing losses but also in maximizing the efficiency of capital allocation in trading activities.

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