Risk-reward compares a planned loss with a planned gain under stated assumptions.
Scenario
Define entry, invalidation and target assumptions before calculating the ratio.
Probability
A high ratio can still lose if the scenario is unlikely.
Portfolio context
Position size and correlation matter as much as the ratio.
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Risk-reward is a scenario framework
Risk-reward compares potential outcomes under defined assumptions. It is not a guarantee that the reward will occur or that the risk is limited to the scenario you imagined.
Define the downside first
Identify what would make the thesis wrong and what price or business condition corresponds to that invalidation. Then model plausible upside cases.
Probability matters
A 3:1 payoff ratio is not automatically attractive if the upside case is remote. Combine payoff size with scenario probability and uncertainty.
Asymmetric outcomes
Look for situations where downside is bounded by strong balance-sheet or valuation support while upside comes from multiple independent drivers. Be explicit about what could break that asymmetry.
Risk-reward checklist
- ☐ Bear/base/bull cases written
- ☐ Invalidation defined
- ☐ Probability assumptions challenged
- ☐ Liquidity considered
- ☐ Position size reflects downside