Direct answer
Risk Reward Ratio (RRR) compares the planned magnitude of a potential gain to the planned magnitude of a potential loss. The main risks are that the underlying assumptions behind the numbers often break in real conditions: execution costs, changing market behavior, operational limits, and how people interpret the ratio. Even when the calculation is mathematically consistent, the realized outcome can diverge materially.
Mechanism and definition
RRR is typically expressed as:
- RRR = (potential reward) / (potential risk) A common workflow is to define a “risk” level (for example, where a position would be closed if price moves against you) and a “reward” level (for example, where you would close if price moves in your favor). The ratio then summarizes the size difference between those two distances.
Key stable mechanics:
- It is a planning metric derived from chosen reference levels.
- It does not itself provide the probability of reaching the reward level versus the risk level.
- It does not include all real-world frictions unless you explicitly model them (fees, spreads, commissions, and slippage).
Variable elements that can introduce risk:
- Where your levels end up being used in practice (order types, fill behavior).
- What the market actually does between the levels.
- Whether the ratio is interpreted as a guarantee of performance, which it is not.
Evidence, example, and realistic scenarios
Consider a simplified scenario with clear assumptions:
- You set a planned entry price, a risk level, and a reward level.
- Assume your broker/platform can execute orders exactly at those levels.
- Ignore commissions for the moment.
If the market moves favorably to your reward level, the trade realizes the planned reward distance. If it moves against you to your risk level, it realizes the planned risk distance. Under these idealized conditions, RRR describes the payoff magnitude relationship.
Now change one condition at a time:
1) Execution and cost risk
Even without changing your chosen levels, real execution can differ. Slippage means the fill price is worse than expected; spread and fees effectively widen the gap between your entry and your “true” risk. Result: the realized loss can be larger than the planned risk distance, and the realized gain can be smaller than the planned reward distance. RRR remains the same by your original math, but the realized ratio shifts.
2) Market behavior and path risk
RRR assumes a level-to-level outcome, but real price movement is a path through time. A trade can experience partial progress toward reward and then reverse before reaching the reward level. Volatility changes can also alter how often reward gets reached before risk. In such cases, two traders with the same RRR can experience very different results because the frequency of hitting reward versus risk changes.
3) Counterparty and operational risk
Order handling details matter. If your platform queues, partially fills, re-quotes, or applies constraints (for example, around order modification), then the effective exit and entry prices can deviate from the planned reference levels. Liquidity conditions can increase the chance that exits do not occur exactly where expected. This is a “model vs. implementation” failure mode.
4) Interpretation risk
RRR is often misunderstood in at least two ways:
- Probability confusion: Treating a high RRR as if it implies a high chance of success. RRR describes payoff size, not the likelihood of achieving it.
- Scenario omission: Ignoring that some losses may occur without reaching the exact defined risk boundary (for example, due to execution gaps or order limitations).
A material limitation is that RRR alone does not address position sizing and overall risk exposure. A strategy can look attractive on a per-trade basis yet create unacceptable drawdowns if multiple trades overlap or if losses cluster.
Limitations and verification risks
Important limitations to keep separate:
- Historical relationships do not ensure future results. Even if certain setups produced favorable outcomes in the past, market conditions can change.
- RRR is sensitive to your chosen levels. Different definitions of “risk” and “reward” create different ratios.
- Assumptions must be stated for any example. If you assume exact fills and ignore costs, your comparison is incomplete.