Profit-Loss Ratio: Calculation, Importance & Interpretation

Profit-loss ratio refers to the relationship between the expected profit of an investment, or a series of investments, to the cost of making the investment or investments. The larger the first number (profit) to the second number (loss), the better the ratio. If the ratio is ever flipped, with the loss being greater than the profit, the investment results in a net loss of capital. Typically a ratio of at least 2:1 or more ideally 3:1 is considered a sign that the investment or investment strategy has been successful.

Step 1

Determine the price of the investment. For example, if 100 shares of a stock are purchased at $10 apiece, the cost is $1,000.

Step 2

Determine the profits or expected profits from an investment. For example, if 100 shares of that same stock reach or are expected to reach $19 dollars per share, the profit is $1,900.

Step 3

Write the ratio of profit to loss, written as profit:loss. Using this same investment example, the ratio would be written as 1,900:1,000.

Step 4

Simplify the ratio of profit to loss. This can often be done by dividing the profit and loss by a common factor. For example: (1,900:1,000) divided by 1,000 = 1.9:1. This is the profit-loss ratio, and it indicates that the investment was mildly profitable.

Tip

For a series of investments, find the average of the profits by adding together the profit of each individual investment and dividing by the number of investments. Then find the average loss of the investments by adding the individual costs and dividing by the number of investments. Write out the profit/loss numbers and find the average ratio.