Risk-reward Ratio

Risk-reward Ratio compares the planned loss with the planned profit of the same trade. CME presents it as one perspective on risk management. The notation must say which quantity comes first: risk to reward is not the same number as reward divided by risk. In this entry, risk is the positive magnitude of a loss and reward is a positive profit; an actual negative outcome is shown with its sign. Here the word reward does not mean an expected or guaranteed return. [1]

For a simple long spot position, the planned price loss is quantity multiplied by the difference between entry and the losing exit. Price profit uses the difference between the profitable exit and entry. CME emphasizes both stop distance and the value of a price tick when sizing a position. The same geometric ratio can therefore represent very different monetary exposures. Contracts require their multiplier and payoff method; the simple spot formula cannot be transferred to options or an inverse contract without checking. [2]

Purchase and sale fees reduce the profitable alternative and increase the losing one. It must be stated whether they are already included in the compared amounts. Coinbase distinguishes maker and taker fees by individual fills; actual costs are therefore not a universal constant for every order. Financing and other charges belong in the calculation when applicable to the product. Spread and slippage included in actual prices must not be counted twice. [5]

In its discussion of mathematical expectation, CME combines win and loss frequencies with their average sizes. Planned price distances do not determine those frequencies. Moving the target farther away can increase the calculated profit, but cannot establish that the probability of reaching it remains the same. A break-even threshold can be derived only for an explicitly specified outcome model. It is a condition on an unknown success rate, not an estimate of it or confirmation of a trading edge. [3]

For stock stop orders, FINRA warns that the trigger price is not a guaranteed execution price; a limit variant may not execute at all. Coinbase likewise distinguishes market and limit execution according to the available book and product restrictions. Losing and profitable exits are therefore assumptions of the plan that must be separated from actual fills. A ratio calculated from drawn levels guarantees neither a loss cap nor target execution during price gaps or insufficient liquidity. [4] [6]

If part of a position is sold earlier and the remainder differently, the whole position cannot be evaluated solely by its most distant target. Coinbase describes partial fills and different ways to retain or cancel the remainder. The calculation should therefore use the quantity and price of each closed part and allocated costs. No fill or an open remainder is not a completed loss or win. The planned ratio and the empirical ratio of average realized profits to losses are different measures. [6] [3]

In discussing hypothetical results, NFA highlights the benefit of hindsight and imperfect representation of liquidity, slippage and behavior during losses. Selecting only charts where a distant target worked therefore does not demonstrate an advantageous rule. Evaluation needs to distinguish predefined conditions from changes based on a known outcome and disclose unexecuted trades and costs. The fictional calculation here explains definitions; it is neither a historical test nor a strategy's performance. [7]

In a risk management plan, CME distinguishes the risk of an individual trade, simultaneous positions and the account's overall exposure. The ratio alone does not show position size, holding period, liquidity or joint movement of multiple exposures. Comparisons require matching currency units and a clear cost scope, while also showing actual monetary amounts. The definition does not imply a universally correct ratio. Review continues with probabilities, the outcome distribution and the ability to bear losses. [1] [3]