StrategyBeginner#Risk Management#Core Concept
Risk-Reward Ratio
R
Definition
A planned comparison between a trade's stated loss threshold and target. It is a scenario calculation, not the probability of either outcome, a guaranteed payout, or evidence that a trade is favorable.
Source reviewed
- SEC Investor Bulletin: Trading Basics opens in a new tab
Supports: Explains market-order price is not guaranteed in fast-moving markets and limit orders may not execute, relevant to stop and target execution assumptions.
- SEC Investor Bulletin: Performance Claims opens in a new tab
Supports: Explains that performance calculations depend on assumptions and past performance does not necessarily predict future results.
Concept Diagram
Key Takeaways
1
Risk-reward compares stated scenario inputs, not probability, expected value, or a guaranteed payout
2
Stops and targets can gap, remain unfilled, partially fill, or realize different prices and costs
3
Evaluate market, orders, size, leverage, costs, liquidity, correlation, probability assumptions, and out-of-sample evidence
4
A ratio can clarify a plan but cannot make an uncertain market outcome certain
Practical Example
A plan enters an asset at $100, sets a $97 stop and $109 target, and calls the pre-cost price distance 1:3. The reviewer also records order type, size, fees, spread, slippage, leverage, liquidity, and the possibility of gaps or partial fills. They do not turn the ratio into a profit forecast.
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