# Is the risk-reward ratio considered in Quantitative Finance?

Many discretionary traders swear by risk-reward ratio, as in "The minimum risk-reward ratio for a Forex trade is 1:2."

Do quantative traders use risk-to-reward ratio as well? If so, how do you calculate the minimum risk-reward ratio?

• Do you know what the Sharpe ratio is? Commented Nov 6, 2013 at 3:11
• Quants do not care about risk-reward, its not part of their job description. Strategists and traders do. Commented Nov 6, 2013 at 14:33
• @Matt Wolf By traders, you mean discretionary traders, not quantative traders? Commented Nov 6, 2013 at 21:57
• @TomTucker, with traders I mean anyone who takes and manages risk, someone who signs responsible for profits and losses. Commented Nov 6, 2013 at 22:39
• @MattWolf Not sure how you define "Quants", but it seems to me that this is at the heart of our field. Commented Nov 7, 2013 at 2:40

Maximizing expected return while minimizing risk is at the heart of the quantitative revolution in finance in modern portfolio theory.

Starting with Harry Markowitz (1952) "Portfolio Selection", a huge portion of quantitative finance is dedicated to refining the ideas around mean-variance portfolio optimization. The objective is to find a weight vector $w$ that will minimize:

$$w^T \Sigma w$$

subject to:

$$R^T w = \mu$$

When evaluating performance, the Sharpe ratio is the most widely used performance measure, and it directly (if a little crude) addresses the trade-off between risk and reward.

$$S = \frac{E[R-R_f]}{\sqrt{\mathrm{var}[R]}}$$

I recommend reading Peter Bernstein's "Capital Ideas" as a gentle introduction to this subject.

• if this is "quant" to you then what is not? Portfolio selection and Modern Portfolio Theory (MPT) lies pretty much at the heart of any discretionary and on-fundamentals focused portfolio manager. I guess knowledge of MPT is most likely tested in one of the first interview questions of any junior starting out in the traditional buy-side industry. Commented Nov 7, 2013 at 3:04
• @MattWolf well as surprising as it might sound, you will find a lot of finance professionals who can't write down these "equations". You might consider a lot of people as non-quants for you because of your background and line of work but I'm pretty sure you'd be surprised how quickly you can be considered as a quant in some companies.
– SRKX
Commented Nov 7, 2013 at 8:05
• @SRXX, fair point which is why I qualified my comment in response to the question above in that it reflects just my opinion and not necessarily a universal view. It is just that I find the term "quant" in general quite overrated. I do not consider myself a quant because I lack a rigorous mathematical and/or statistical background. Commented Nov 7, 2013 at 8:14