Efficient Portfolio

It is possible to calculate the risk/return ratio for every possible portfolio at any given time. This ratio for the portfolio is composed from the risk/return ratio of all stocks in the portfolio AND the risk/return ratio of the stocks to each other. The right combination of stocks can substantially minimise the risk of a portfolio.

It becomes possible to compare portfolios with each other. Each dot in the above image represents one possible portfolio. As this graph clearly shows, there is only a certain range with regard to the relationship of risk and return, where portfolios can be situated. If the topmost points are connected, a line becomes visible: the efficient frontier line. All portfolios on this line have the optimum combination of stocks, meaning an optimum risk/return ratio. All those portfolios give the highest return for the amount of risk an investor is willing to take--or defined in another way, have the lowest risk for the return to be achieved.

As you can see in the risk-return portfolio graph, at a certain level, the gradient of the efficient market frontier line drops. At this level you have to risk more for the same profit increase in percentage terms.