Direct and indirect costs that change the real risk and real reward
A “Risk Reward Target” is usually described as a ratio that compares a potential loss (risk) to a potential gain (reward) based on where prices move. In practice, the ratio can be different once costs are included, because costs change the executed entry/exit prices and the net profit or net loss.
Costs that can affect a Risk Reward Target fall into two main groups:
- Direct costs (per-trade and price-friction): items that apply immediately when entering or exiting.
- Indirect costs (timing and execution effects): items that depend on how fills occur, how quickly the trade runs, and what happens after execution.
This article explains the mechanics, shows an example with stated assumptions, and lists common limitations and failure modes so the reader can verify inputs independently.
Mechanics: where costs enter the Risk Reward Target
Cost types that directly change reward and risk
- Spread (bid/ask difference). When you buy, you enter near the ask; when you sell, you enter near the bid. That means the initial “distance to target” is effectively changed by the spread.
- Commission or per-lot fees. If a provider charges a commission per trade or per volume, it subtracts from net reward and increases net risk (because costs add even if the price moves exactly as planned).
Cost types that can indirectly change outcomes
- Slippage (fill not at the expected price). If the market moves between the moment an order is placed and when it is filled, the executed entry price and/or exit price can differ from the reference used to set the target.
- Financing or rollover charges (holding cost). Some forex positions are affected by time-based financing. If you hold beyond certain times, the net result can shift even if the price path matches expectations.
- Swap-related or interest-related adjustments (jurisdiction/provider dependent). The exact method varies, but the general point is that time can add or subtract from the P&L.
Key assumption used in most “ratio” examples
To keep a calculation meaningful, you must state what price levels you assume:
- Are you using the mid price, the bid/ask, or an expected fill price?
- Are you adding fees separately, or assuming a “clean” execution with zero costs?
- Are you assuming no slippage and a fixed holding time (for financing)?
Without explicit assumptions, the Risk Reward Target ratio can silently drift from the “planned” ratio.
Evidence or example: how costs can break a nominal ratio
Assume the following (these are simplifications for illustration):
- You set an entry at a reference price and define a stop distance and a target distance.
- The market moves exactly to your target, and you exit.
- You ignore slippage for the moment.
- You include a spread and a commission.
Example setup (assumptions stated):
- Planned gross reward is based on a target that is X price units above entry.
- Planned gross risk is based on a stop that is Y price units below entry.
- The planned ratio is therefore X/Y.
Now include direct costs:
- Spread effectively reduces the net gain for the direction you trade, because your average fill is not at the same level as the reference.
- Commission reduces net reward by a fixed amount per trade.
Result: even if the price reaches the same target and stop levels relative to your reference, the net reward is smaller and the net risk is larger (or at least less favorable). The effective ratio becomes smaller than the planned X/Y.
A material limitation in this example is that it assumes zero slippage and ignores time-based charges. In real markets, slippage and financing can change the realized outcome after execution.
Limitations and risks: common failure modes
- Execution variability: Slippage means the actual entry and exit can deviate from the levels used to compute the ratio. 2. Reference-price mismatch: If you built the ratio using mid price but your execution uses bid/ask, the spread creates a systematic difference. 3. Time-based charges: Financing/rollover can add or subtract from profit depending on holding time. A strategy with the same price outcome can still have different net results. 4.