Direct answer
Risk reward limitations mean that the neat idea of comparing potential reward to potential risk often breaks down in practice. Beginners should treat risk reward as a way to frame assumptions, not as a promise about outcomes. When actual execution, costs, and market movement differ from the inputs you used to calculate a ratio, the result can be less favorable than expected.
Mechanism and definition
Risk reward usually starts with two distances measured from an entry reference: a risk distance (often linked to where a position would be closed to limit loss) and a reward distance (often linked to where a position would be closed to capture gain). From those distances, people compute a ratio such as: reward divided by risk.
A key beginner point is that any numeric “risk reward” figure depends on what you assume:
- The reference price used for entry.
- The assumed stop and target levels.
- Whether you measure distances in price terms, pip terms, or percent terms.
- Whether you include transaction costs and execution effects in the calculation.
If your calculation ignores costs (for example, commissions and spread-related effects), your real risk and real reward can diverge from the simplified ratio.
Evidence or example with explicit assumptions
Scenario (no live data): Suppose you calculate risk reward using a simplified assumption that every position exits exactly at your planned stop or target levels, and that trading costs are zero.
- Assumed risk distance: 10 units
- Assumed reward distance: 20 units
- Assumed risk-reward ratio: 20/10 = 2
Possible limitation: if slippage or execution timing causes an adverse exit beyond the planned stop, the realized loss can be larger than your assumed “risk.” If costs widen the effective entry/exit difference, the realized reward can be smaller than planned.
Another failure mode is definitional: different people may use “risk” and “reward” inconsistently (for example, using distances without translating them into the same money terms). That can make comparisons misleading even when the ratio looks the same.
Limitations and risks
Material limitations beginners should expect:
- Variable market behavior: price paths can reach your stop and target at different times, and sometimes the market can move in ways that make your planned levels less representative of reality.
- Costs and execution differences: spreads, commissions, and slippage can shift the effective realized outcome away from what the ratio assumed.
- Assumption sensitivity: small changes to entry reference, stop level placement, or cost assumptions can change the effective risk-reward relationship.
- Non-predictive history: a past pattern of high ratios or high win rates does not guarantee future results, because relationships can change with volatility, liquidity, and trading conditions.
A practical “control point” is to ask, before any comparison, what exact assumptions must hold for the risk reward ratio to match realized outcomes. If those assumptions are not realistic, the limitation is built in.
Verification and next question
To verify risk reward limitations independently, keep the definitions consistent and test the assumptions you used:
- Recalculate the risk and reward using the same units (price terms vs money terms) and the same reference points.
- Include a cost model in the calculation (at minimum, spread and any known commission assumptions).
- Consider a worst-case execution scenario relative to your planned levels (without assuming perfection).
Next question to explore: which specific assumption in your risk-reward calculation is most likely to differ from reality for your situation—costs, execution timing, or the level definitions you used?