R (R-Multiples) Defined

There seems to be a lot of controversial over the concept of R-Multiples. I’ve been seeing people complain about them for months now and I’ve been meaning to write a post about “R”. I really wanted to do it last week but I’m glad I didn’t get to it because this week a raging debate about R has popped up. Glenn, at DehTrader can serve as the poster child for the anti-R crew. Here’s part of his recent rant against R-Multiples (emphasis is mine):

I post real numbers as opposed to R values, I always have. I like real numbers, I understand real numbers and I see truth in real numbers and I think the reader does too. As a reader of many blogs I find zero value in any post or summaries containing R values, I don’t see any point in sharing that information. I suppose if I posted in R values I could look like a pretty good trader, but we all know I am a struggling trader. R can mean anything so why even bother with it… R stands for bullsh!t imo and that’s my rant (that and ads haha). The best blogs out there post real numbers, Boogtser, JC (NYSE), the Kirkster all come to mind.

He’s joined by folks like Paul who left this comment over on Ugly’s post about R multiples:

I believe dollar values are more important than R value. I agree that the actual $ value is meaningless. However, R values are subjective and don’t give you a true idea on how successful the trade was. If you defined your risk at 15 cents and made 30 cents on the trade, while another person made 50 cents but decided his risk would be 50 cents, R values would say the guy who made 30 cents was more successful. I have a problem with that. It could very well be that the guy who only risked 15 cents is playing it too safe and his 2R gain was a bad trade.

So that gives you an idea of the anti-R sentiment. I’m going to explain why I think R-Multiples are so useful and why I use them in my trading and on this site.

What is R?

R is simply the dollar risk per trade. It’s nothing but a reward-to-risk ratio. I first heard it called “R” in Van Tharp’s book “Trade Your Way to Financial Freedom“. In another of his books, “Financial Freedom Through Electronic Day Trading“, Dr. Tharp reveals the great secret of trading:

The golden rule of trading is to keep losses at a level of 1 R as often as possible and to make profits that are high-R multiples.

You often hear (read) that traders should only look for trades with a reward/risk ratio of at least 2 or 3 to 1. Expressing your results in terms of how many times your risk allows you to easily see how well your trades measure up to such a standard. So when I look at my results in terms of multiples of R I can easily tell how good or bad the trades were. I like to think of R-Multiples as telling you the efficiency of your system.

So why not just use dollars?

Expressing my results in dollars would achieve the same result if I always risked the same amount of money. But what if I triple my account and therefore trade larger positions compared to when I started trading? Or what if I hit a rough spot and decide to cut my share size down while I ride out the storm? Then the dollar results won’t easily tell me how trades from one period of time compared to another period of time. But if I use R making such comparisons is simple. Either my trades passed the risk / reward ratio test or they didn’t. The actual number of dollars at risk doesn’t matter, how many multiples of the dollars at risk does.

Along the same lines, recording trades in terms of R-Multiples allows you to easily calculate your system’s expectancy. (Follow the link for why you should care about expectancy.)

Also, as reader Rx said:

talking and thinking in terms of R-multiple when you discuss about profits is an excellent approach – that by itself makes you focus on risk and money management – the actual “grail” to successful trading.

That is a very important point. Whenever I see people posting dollar returns, especially losses, that are all over the place the first thing I ask myself is “I wonder what his risk per trade is”. It’s almost a certainty that those traders aren’t focusing on risk and as a result keep having huge losses. The mere fact that you have to define R and then place a stop to keep your loss to 1R is probably too constraining for those gamblers traders. Dr. Tharp says about determining your initial stop-loss point as soon as you enter a trade, which, by definition woud give you a 1 R loss:

This principle is so important that if you cannot follow it, then you might as well give up the idea of electronic day trading right away.

The reason I use R on the blog is because I don’t want to discuss dollars or my account size on the site. That’s nobody’s business but mine. Also, it makes it easy for people to figure out what they could have made or lost on a trade with their own account size and risk per trade amount. If you see a trade that returned 3R all one has to do is plug in their dollar risk per trade to figure out what they could have made / lost.

To the R Haters

Let me address the “alleged” issues which I quoted above…

Glenn thinks that R is just some made up number and could mean anything. He likes “real” numbers. While it may be fun to see that somebody made $10,000 on a trade that in and of itself doesn’t tell you how good that trade was. What if that person risked $30,000 to make that $10,000? Or what if they risked $1,000 to make that $10,000? Those are two very different trades. Sure they both made the same amount of money but isn’t the second trade a much more efficient use of capital?

What if somebody is trading $500,000 lots to make $1,000 in profit? It may be nice to see somebody saying that they made $1,000 here and $1,000 there but damn(!) that’s an inefficient use of capital. So while R could mean anything in terms of dollars, in my humble opinion what really matters is how many multiples of R were made or lost. That tells you the quality of a trade or system.

Glenn also states that if he reported his trades in terms of R he could appear to be a good trader. I’m sorry to tell him that’s simply not the case. If you lost money that means your expectancy, which is just your average return expressed in R-Multiples, was negative.

Paul said that “R values are subjective and don’t give you a true idea on how successful the trade was”. That is exactly wrong. R-multiples are the very thing that tells you exactly how successful a given trade was, if you choose to grade on a risk/reward basis.

Percentages vs. Dollars

This debate about R reminds me of a conversation I had a couple of weeks ago. I was in a presentation for Trade-Ideas’ new tool, the Odds Maker. They were showing how you could backtest all these different scenarios with the tool. The results were expressed in average dollars won or lost. Another viewer and I asked about seeing the results in percentages. They kept saying that perhaps they would do that in a later revision. I kept harping on it because to me seeing the results in dollars was of little use for the way I size my positions

The argument from the presenter was that all you had to do was multiply the average dollar return by your average lot size to figure out how much money you could have made with a given system you were testing. I had to disagree because my lot size can vary drastically depending on how far away my stop loss is. Here’s a situation which could be problematic — I trade Google with a 2 point stop (which is only about half of a percent) and get lucky and make 6 points of profit. All of my other trades are on stocks under $50 with stops less than 50 cents. I could have some combination of winners and losers mixed in there… most of them probably well less than $6. That $6 gain may skew the results when presented as average dollars won. That’s an over-simplification and there are all kinds of possible permutations. But I hope my point is clear that looking at the results in terms of average dollars won/lost may not tell accurately tell you the story.

So how can we make the results clearer? Simple, express them in percentages. That way, regardless of how many shares were traded or the prices of the stocks traded the results can be equalized across all the trades. I feel much better being able to say , “OK, this system would have returned X%” instead of “X number of points.

We debated the merits of each way of reporting for a few minutes and at one point somebody said, well , for this release we’re aiming for the “lowest common denominator”. In other words, the average person can’t think in percentages, so we’re just gonna report in points. I was like, F the average person, make it work the “right” way! The funny thing is that after debating all of that the software actually could express the results in percentage terms. We just had to switch a setting.

So my point of that little story is that I always prefer to think in terms of percentages in stead of points. I always see people talking about number of shares of point moves. For example, you might hear somebody exclaim “Google is up 5 points!!!” I don’t see that as anything to get excited about. That just over a 1% move — a normal fluctuation. You’ll hear similar things from reporters talking excitedly about the Dow being up some triple-digit amount. The Nasdaq may actually be up a lot more on a percentage basis but they’ll just say, eh, the Nasdaq is “just” up 30 points.

Looking at the percentages makes those kind of comparisons easier. R-Multiples do the same thing for traders. They can accurately compare their own trades and they can take another trader’s results expressed in R and easily relate them to their own system.

Comments

  1. Posted by troy on September 6, 2006 at 9:42 pm

    This is one of the best posts I have read in a long time. People fail to understand this quite simple concept. People see an ad with someone saying they made $5000 in one day trading stocks. This means nothing to me without understanding the risk took to make that money, and how that relates to the size of the overall account being traded. If you need to put a $ in front of your trading results to feel better, knock yourself out. As long as you are focused on controlling your risk you can brag however it feels best. Controlling risk is the �key to the kingdom�.

  2. Posted by Michael on September 6, 2006 at 9:47 pm

    Thanks Troy. You make a great point about those type of ads.

  3. Posted by DLarsen on September 6, 2006 at 9:49 pm

    Interesting read, Mike.
    I can sympathize with Glenn to some degree. Yesterday, as I was reviewing my trading journal, I came across some sloppy trades where (I hate to admit) I hadn’t explicitly defined R. I had no stop in place, and brainlessly proceeded by following my “gut” instinct. Recording reults in terms of R is problematic in these cases. I don’t want to omit the trades from my journal, but I realized R was arbitrary at this point. There was a temptation to record R values so my losses looked smaller (larger initial R) and my profits looked bigger (tiny initial R).
    As with any set of statistics, it’s easy to fudge the numbers to reflect better upon your record. Hopefully, we’re all more concerned about improving actual performance than tweaking R to boost our ego.

  4. Posted by Michael on September 6, 2006 at 9:55 pm

    DLarsen,

    It sounds to me that R isn’t the problem, your lack of defining R on those trades is the problem. And that’s the kind of thing that should make you realize that you always need to define your initial stop-loss point.

    In cases like you describe I would just take your average R for the last few weeks or so and then calculate it for those “off the cuff” trades.

  5. Posted by Paul Singh on September 6, 2006 at 11:28 pm

    Hi Mike,
    I noticed you quoted my comment above. Please note that in my next post on Ugly’s site, I made sure to mention that measuring risk is important, risk should be taken into account in every trade and a risk of less than 1:1 should never be taken (and even that his a high risk for me). However, when it comes to logging trades (whether it be public or private), I believe percentage or dollar amounts are more important. Viewing the dollar or percentage amounts, I can get a better feel for how I’m trading. I can see exactly where I made my bigger postion size bets, which you can’t with Rs, and how they turned out. What does making +5R really tell you? It certainly does not tell you how much money your making. In fact, you could have a 5R week and still lose money, since amount risked is different for each trade.

    Of course, in my own personal trading journal I log both dollar and risk. They don’t have to be mutually exclusive.

  6. Posted by Michael on September 6, 2006 at 11:33 pm

    Paul, That’s true if you let R fluctuate wildly from trade to trade but some of us keep R constant. Mine is always a certain percentage of my equity.

    I keep track of dollars in my trading journal as well but in my opinion, the interesting & valuable analysis is gleaned via R & expectancy

  7. Posted by Zoomie on September 6, 2006 at 11:38 pm

    Great article TM!
    I went to a Pristine seminar, free one…lol, and the one topic that the speaker, Mr. Knott, said was the most important aspect of trading…. keeping your risk uniform throughout your trades. All the pros hammer this home. I figure I should listen ;).

  8. Posted by Carey on September 7, 2006 at 12:06 am

    As a personal performance measure, you make a great case for the value of R. If one is correctly evaluating their risk, their trades should meet (or exceed) their expectancy. Thus, if one honestly evaluates their trades, R becomes an essential self measure of performance.

    The difficulty comes in using this as a measure to evaluate others. If novice trader Z is deciding whom to learn from (trader A, B, or C) and the only data available is a smattering of R values for various trades, it’s very hard to determine the performance of each trader (it’s not always clear if somebody sets R as a constant percentage of their equity and not everybody states when they reached 100R). Whereas, if one is presented with % return/year (still avoiding dollar signs) in addition to R (or at least of sample of trades to help you evaluate the perceived risk), you instantly have a sense for whether they are successful.

    Thus, R only bothers me because it paints an incomplete picture when evaluating the performance of others. Besides, if % return/year were not also important, you probably would not have polled everybody on this.

  9. Posted by Alan on September 7, 2006 at 12:12 am

    This is the best explanation I have seen of why calculating ‘R’ is so important. I guess if you want to impress your friends, tell them how much money you made. If you want to impress yourself, figure out your ‘R’ multiple.

  10. Posted by Michael on September 7, 2006 at 12:14 am

    Carey,

    That’s exactly why I posted percentage returns along with my results when I made my 100R post. People still weren’t happy. Oh well — their problem, not mine

  11. Posted by Glenn on September 7, 2006 at 1:53 am

    I fully understand R is very important and I use it myself every damn day. I also understand not wanting to reveal how much or little money one makes.

    I’m just an average guy and an average blog reader and am simply stating that as a reader, R summaries or trades posted are of no interest.

    In the last two days Ugly has posted dollar values on two very nice trades, for the first time I can get a real sense into the trades he is making. As a reader of his blog, the value level just went up for me personally. If no one can understand that then I must be way out in left field (which is normal). Over and out.

    P.S. You are a very good writer Michael

  12. Posted by Rx on September 7, 2006 at 4:01 am

    Those who dislike the R-concept and see it as a meaningless measure are not understanding the context that the R needs to be put in. The context is the “percent risk model” – a specific position sizing model. See Mike’s post about position sizing for a detailed description – that’s a VERY educational and a good post, where I came up with my position sizing strategy as well. Before that, I had a lousy system for sizing my positions – usually a fixed $ amount or sometimes even worse, an arbitary $ amount that I just came up with somehow. I also had the rule of keeping my position sizes smaller than 35% of my account, which I now find unnecessary. At times, I simply bought 300 or 400 shares of stock X without thinking how much of my portfolio I’m actually risking with a given stop on that trade (fortunately, I did always have stops). This is extremely poor risk management and here, the R really means nothing indeed.

    R – the Risk – is NOT a random value that is simply derived from the size of a given position. Quite the opposite – the position size itself is calculated from the R value. This is a part of the “percent risk model” position-sizing strategy, which consists mainly of the following two rules:

    – You keep your risk per trade constant. It may be an absolute value such as $500, or $200, but “percent risk model” suggests that you define it as a percentage of your account – reasonable would be 1%, 1.5%, 0.75% or even 0.5%. This is to allow compounding.

    – BEFORE you enter the position, you must know your exact entry and exit (stop) levels – these are a part of your TRADING PLAN and your risk is the difference between your entry and stop levels. Then, based on that difference and your R (say, 1% of your account), you risk equal percentage amount each trade, but your position sizes vary greatly – depending on the risk.

    This is why some people say: “Hey, I bought 500 shares of X and 3000 shares of Y, on one the R is $200 and on the other the R is $900 – so this R doesn’t mean anything, talking in terms of R is bull**!”.

    That’s exactly how R-based position sizing (risk management) does NOT work and true – that’s where R is completely meaningless. The meaning comes from keeping R basically a constant over all your trades (or varying it very little). Of course, letting people know if your R is 1.5% of your account or 1% of your account, is also necessary – that’s what actually defines the risk size and also the position size on a given trade that you present to your blog readers. I personally am not too impressed to see a guy make $1000 on a trade, while having an account size of $2,000,000 and a risk of $700 on the trade. In other words, his R was 0,035% of his portfolio and his risk-to-reward ratio was 1.42. That’s a poor risk-reward ratio and extremely poor use of buying power (position sizing strategy). Sure, $1000 is a nice amount to see, but as a trade.. is it really a good one? The answer’s obviously NO.

    As a simple example (with all REAL $$$ amounts as well):

    Let’s assume you have a $30,000 account. Your R – risk per trade – based on your risk management strategy is 1% of your account – it’s FIXED. So on the next trade that you’ll take, you allow yourself to risk $300 (1% of $30,000). No more. So this $300 is the key figure that tells you the number of shares to be bought.

    You have a plan to enter a stock, when it goes above 21.50 – let’s say, at 21.52 you decide you get in (place a stp lmt buy order, for example). You see a support level at 21.15, so you set your stop below it – say, 21.14. This stop may be an alert stop, stop loss order, whatever – that’s up to you and your trading style. The point is, that here the risk is 21.51 – 21.14 = 0.37 per share. So, this must equal 1% of your portfolio, because your R is 1% of your account as said before. 1% of $30,000 is $300, so you get to risk $300 on this position, therefore you buy $300 / 0.37 = 810 shares exactly. This way, when you lose and exit the position with your stop at 21.14, you lose exactly 810 * 0.37 = $300, or 1% of your portfolio.

    Your position size is calculated based on that R. It is 810 (shares) * 21.52 (entry price) = $17,341 – which is 58% of your portfolio. Remember, you’re NOT risking 58% just because your position is this big – you’re only risking 1%, or $300, or 37 cents per share. Let’s say this is a successful trade and you pull 2.5R out of it. That means that you exit with 0.37 * 2.5 = $0.93 gain at $21.52+$0.93 = $22.45. This is a fairly good risk-to-reward trade already. You gain 2.5*$300 = $750 on a trade, that you risked $300 on – that’s what can be considered a GOOD trade. Now your account grows to $30750.

    Keeping your R constant would mean that on your next trade, you can already risk 1% of $30750, which is $307,5. Trying to keep your MINIMAL risk-to reward ratio the same – say, 2.5, is also a very important part. And you only consider taking trades, that have the potential to give you 2.5R AT LEAST. This is all money and risk management, that’s been covered by Mike in detail before – I’m just going over the basics here because it is extremely important.

    My personal risk management involves having a FIXED R value of 1.3% of my portfolio and an expected risk-to-reward ratio of 2.6. I have made an excel spreadsheet, that, based on the Risk-Reward ratio, the account size and the R, gives me the share amount, the initial profit target and also the expected percentage gain when I input my entry and exit levels – just 2 numbers. I only take positions that have the potential to reach that target and give me this risk-to-reward ratio of 2.6 at a minimum. More is, naturally, always a very good thing and can already be considered as a little extra bonus.

    How you manage your trade once it reaches your target is a whole different topic that people write big and heavy books about and quoting Mike: “It’s more of an art than exact science” – it really is.

    R-multiple approach is purely about focusing on risk a lot more than the reward. In many blogs you see the R, but it seems meaningless to you – well, it should be written on that same blog somewhere, that the R is x% of that person’s account size. It’s mentioned somewhere, I can assure you. If it’s not – ask. Ugly from uglychart.com, varies the R from 0.5% to 1.2% as far as I’ve noticed, but I like keeping the R constant because by letting your R fluctuate that much, your own psychology will trick you most of the time.

    If Murphy had laws for trading, one would be something like “Your biggest losers occur at your highest R value and you always get your huge gains when your R is the lowest”. It tends to be exactly that way and I keep the R constant just to avoid that psychological issue. Even when it’s constant, you’ll win more each trade when you have a winning streak and you’ll lose less on each trade when you’re having a losing streak. That’s the beauty of compounding and percent risk model – it’s always on your side, in both excellent and disasterous times.

    Most traders following this position sizing model keep their R between 0.5%-1.5%. An R of 2%, for example, could make your position size perhaps up to 150%-200% of your portfolio and many (including myself) are not comfortable with a position this large anymore. So keeping your R around 1% is a good practice and keeping it constant will probably save you from a lot of days cursing yourself and asking repeatedly: “why, why WHY did I have to lower my R to 0.5% just before I had this 7R gain!!!”.

    This philosophy is how I manage my risk and every individual is different. Some will never like the R-concept, but it’s still useful to understand fully, why it exists and why it’s being used even if it doesn’t suit your style. In my view, it’s one of the best risk management strategies one can have – at least, for starters. All kinds of tweaks, bells and whistles can be applied as experience and success build up along time and over trades.

  13. Posted by Michelle on September 7, 2006 at 5:20 am

    TraderM,

    Why not do everything? Do dollar amounts, percentages, R multiples, and don’t forget to videocam yourself trading with audio (so we can hear those sound alerts going off!)

    Seriously, it is a wonderful feature of blogging that there is such a close feedback between reader and blogger. However each blog is the individual’s blog, and that is what makes trading blogs so great.

    However, this excerpt from Glenn’s rant, “So in Aug I had about R trades, I had R wins and way to many R’s. I realize that if I want to do better I need to R. My R was really R so I am not sure if R was the right amount. One of the R’s was a little lower than expected but R was close so it turned out ok. Compared to other R’s my R’s really suck. It is clear I don’t now what the R I am doing”, made me laugh in appreciation of how sometimes quoting of R values are irritating and not the anchor of clear, useful information that a bobbing trader in the treacherous seas of the market is looking for!

    Michelle

  14. Posted by john on September 7, 2006 at 5:32 am

    I made infinite R the other day – the trade was so “right” that I didn’t bother to set a stop – no stop means no risk ergo infinite R.

    Actually I made a buck a share – now you don’t know how many shares I bought but that doesn’t matter because it isn’t relevant except for bragging rights. “My R is bigger than your R.”

    This is a good explanation and argument for the use of R – at the end of it I went – whatever.

    Point is – your percentage of return on this trade or that trade or your R’s on this or that trade are of no importance nor value to anyone other than yourself. No one cares “what” you made – only “how” you made it.

    There is a difference. If I say “I took a trade and made 6 R” everyone goes ooh and aah but that is less significant than “I took a trade off the 3rd 15-minute candle because blah blah blah and I cashed on the 8th 15-minute candle because of blah blah blah.”

    In other words I am more interested in the techniques of finding, capturing, and making money on fine trades than in some measurement of relative value regardless of the method used.

    Freud would have a field day with this – sometimes a cigar is not a cigar.

  15. Posted by Bill on September 7, 2006 at 6:49 am

    Reporting in r-multiples tells people everything they need to know as long as they understand basic risk management.

    The only thing I might want other than the r-multiples is perhaps a dollar amount of the risk per share being taken so I could get a feel for whether someone was using tight or loose stops. That would give me better insight to the trading style but it isn’t really necessary as you can usually get a feel for this by simply reading the blog.

    Keep up the good work Mike. The voyuers will never be happy, even if you publish your actual trading results.

  16. Posted by Michelle on September 7, 2006 at 7:17 am

    TraderM,

    Focus on risk to reward (and R multiples is a elegant way of doing that) is a crucial part of ‘fine’ trades.

    There is plenty of systems delineated and trading rooms on the net, how to locate ‘fine’ trades, and for the majority, their accounts still get blown out.

    In my years of trading, the paradox of the maverick personality (who must think and work for himself), and who is attracted to trading because of this ‘virtue’ of independence, finds himself screwed bigtime because this said virtue becomes a vice when trading without money management (he is too special to bother with something as pesky as risk/reward/money management done CONSISTENTELY).

    Michelle

  17. Posted by eR0CK on September 7, 2006 at 9:52 am

    Just what I was looking for Mike! I was going to look through your site to find info about your use of ‘R Values’, but you’ve made it much easier now :-)! This article coupled with the comments above sure do help many novices like myself understand what’s going on much fuller. Thanks!
    -Erich

  18. Posted by Paul Singh on September 7, 2006 at 10:49 am

    Rx,
    I don’t think anybody is arguing that R is a meaningless measure. It’s muy importante and I log it with every trade. The issue (at least as I interpreted it) is what is more important, logging R values or the actual $,% and postion size numbers.

  19. Posted by boots on September 7, 2006 at 11:16 am

    I use the ‘Constant Risk’ (R) method and have done years of testing with it both in real trading and in hundreds of thousands of simulated trades using TradeStation. I can tell you that using a constant risk factor can turn a lousy trading method into a winner and a good method into an outstanding money maker.

    Aside from all the other advantages of using a constant risk I really like knowing that I don’t have to worry about any of my trades. It takes away the emotion. I pick an ‘R’ that I know won’t hurt me and then enter any trade that meets my specs. Once in the trade it is pretty much an automated process. I have rules for the trade and just run the functions not worring that any one of my trades might set me way back.

    Knowing that just one decent trade can overcome three full stop bad trades makes for a CALM trader and that is about 90% of the battle.

    Keep up the good work Mike.

    boots

  20. Posted by VC on September 7, 2006 at 11:40 am

    Mike,
    Great post. Not sure why people have problem with R. If someone wants to understand the real $$ impact they can assume $100K and back calculate. When you did the 100R post you also provided total number of trades and number of days. By my calaculation if I had $100K for trading I would have made $70K assuming my R=1% of account in xx days.

    Any way, it is good to hear from others and their thoughts on R. It is always a pleasure to read your blog.

  21. Posted by Michael on September 7, 2006 at 11:49 am

    Just hit NYC. Thanks for all the comments. I’ll respond to some of them later this weekend… just a quick note on Rx’s first, excellent, comment. R is NOT tied to the percent risk position sizing model. R is independent of position sizing model. Risk/reward should be taken into account regardless of how you choose to size your positions.

  22. Posted by Ertai on September 7, 2006 at 12:27 pm

    Position sizing should always be related with a % risk or R risk measure.

    Money values aren’t not only unpratical to measure the success of a trade but useless for anyone trying to replicate the same trades / methods.

    Mike you should stick with R and maybe talk more about % per trade risk and the relation to your present R.

    Anyone who does not understand this is simply demonstrating a great lack of common financial knowledge.

  23. Posted by sam on September 7, 2006 at 2:20 pm

    Not sure Glenn can really complain about anything since he blew up his account this month (see his blog on Deh) – maybe he should be figuring out his “R” before he tries again at the markets.

    Honestly, his complaint is so silly, it’s not even wrong.

  24. Posted by Quentin on September 7, 2006 at 9:08 pm

    Mike,

    First, thanks for the execellent topic regarding “R ” and thanks to the posters who have helped make this topic a lot clearer.
    Keep up the good work and wishing you and all the traders in here many profitable trades.

    Thanks……………

  25. Posted by Linda on September 7, 2006 at 10:29 pm

    TraderMike, and all other readers…

    Couldn’t resist jumping into the great “R” debate.

    I really like that JC at NYSEscalper posts his numbers in actual $$, mainly because I don’t know anyone who scalps, or works at a prop firm, so it makes the whole experience much easier to understand. He is a relatively new trader, who has been very honest about his trading, and his future ability to keep trading for a living.

    I understand “R”, but sometimes, after a long day, its just easier to see a number.

    I also have found that when I go out to eat, the check is expected to paid with $$, not “R”s

    🙂

    Always a great discussion on this blog! Thanks!

  26. Posted by tireg on September 7, 2006 at 11:24 pm

    Hey Mike, some excellent points for the use of R. It is definitely a great place to start or continue on the path of money management.

    You can probably sense the BUT coming. I, along with others, do have a few alternative points to its weaknesses. Primarily, the value of R in relation to portfolio in stages of drawdown, as well as R in relation to multiple systems, and dynamic position sizing or dynamic system weighting. To me, it feels like something very important is missing.

    Perhaps acrary summed it best on elitetrader thread ‘What are your trading breakthroughs‘:


    “3. Learning dynamic position sizing

    I’ve always been uncomfortable with using something like risk 1% on a trade with the idea that each trade is independent and has the same potential value. I’ve experimented with different money management ideas over the years. When I think of risk I think of maximum drawdown. If my account is at a equity high risking 1% seems trivial. However if my equity is down 20% from peak then the 1% risk seems like it may be too high. I wanted a way to size my positions so that when I’m killing the market I can trade like a pig. Likewise when I’m being killed I can duck a massive drawdown. I did lots of tests and earlier this year I created a formula that changes the size on each trade based on my equity curve and the level of drawdown I’m comfortable with. What I found was the total profits went way up, the profit factor dropped, and the sharpe ratio went well above 2. I’ve tested it on many models and I’m now using it with excellent results.”

    Another thing that initial ‘R’ does not take into account is open risk (current price – stop), which may be different than initial risk (entry price – stop). The aggregate of these being open exposure and initial exposure. While the risk to your initial capital may be limited by the total R’s you have out, the current portfolio value’s risk actually increases as vehicles move in your favor and away from stop prices.

    As far as minimum risk:reward ratios, as well as the effects of asymmetric AND symmetric stops on a system, I wrote a little about it here to the effect that the proper R:R depends on win probability of a given system. While many say 3:1 is a good rule of thumb, which I do not disagree with, if your system has lower than 25% win rate you will still lose money. (expectancy = .25 * 3 – .75 * 1 = 0)

  27. Posted by tradernovice on September 8, 2006 at 6:10 am

    The problem is not R per se, it’s how individuals view the world. Some people are more conceptually oriented and can view the world in terms of the concept of R. Others are more sensing oriented and need to touch and feel the detail, hence the need for $. Perhaps Brett Steenbarger from Traderfeed could comment!

  28. Posted by mikeb on September 8, 2006 at 7:35 am

    For the case of dynamic risk sizing, it’s a matter of what aspect of your performance you’re trying to analyze as to how R (your initial risk) should be calculated.

    If you want to look at your entry and exit performance, you normalize w.r.t. initial dollars at risk in a trade. For instance, if on tradeA the amount you lose when wrong is $500 and the outcome is either making $1000 or -$500, the outcomes are either 2R or -1R… on tradeB if the amount you lose when you’re wrong is $1000 and outcome is either making $2000 or -$1000, the outcomes are either 2R or -1R. This allows you to quantify your setup and exit performance without the effects of your risk sizing model.

    If you’re looking to quantify the effects of your risk sizing model, you would calculate an average loss and use that as your per trade risk (i.e. R). This, along with the data discussed in the previous paragraph, would give you a measure of how your dynamic risk sizing model performed realtive to a fixed risk model.

    One last point, acrary is correct (no surprise there) in that the best risk sizing model assumes a risk commiserate with the likelihood of a positive outcome. Based on the quote, he seems to have found a method for determining likelihood based on his the performance of his equity curve (i.e. his trade data is ‘streaky’).

    – mikeb

  29. Posted by SteveJ on September 8, 2006 at 8:12 am

    RX said –
    “You keep your risk per trade constant. It may be an absolute value such as $500, or $200, but “percent risk model” suggests that you define it as a percentage of your account – reasonable would be 1%, 1.5%, 0.75% or even 0.5%. This is to allow compounding.”

    Seems like the problem is that R is different from trader to trader. Two guys can do the exact same trade and come up with different R returns. This would make comparison difficult. I like putting things in terms of percentages but I still see problems in putting returns in terms of percentages of a variable R. If I misunderstand please correct me. Thanks.

  30. Posted by democratictrader.blogspot.com on September 8, 2006 at 9:56 am

    Excellent post Mike, I totally agree with you.

    Trading is simple if you reduce it to the success relevant factors and cut out all the noise, which isn’t to say it’s always easy, though, but one shouldn’t make it more complicated than it is, it’s just a probability game where success is down to maintaining a positive expectancy, however you choose to go about doing that, which will depend on your understanding of markets and psychological make-up and needs.

    If you don’t mind higher drawdowns then the most lucrative way to maintain positive expectancy in the long term is by following that ages old adage, letting your winners run, while cutting your losses short, which allows you to be wrong the majority of the time and still be net profitable.

    Another approach is to turn the above around, ie lower your win / loss ratio while increasing your win rate, where now your losses will be bigger than your winners but you’ll have more winners than losers, but from all of what I’ve seen / read that method will never be as long term net profitable as the prior one above, not least due to eventual liquidity problems, but have the upside of lower drawdowns.

    And the way you measure the underlying all important risk / reward part of the expectancy equation is simply through the R concept that Mike has explained so well.

    Have a great weekend 🙂

  31. Posted by democratictrader.blogspot.com on September 8, 2006 at 10:02 am

    PS: Many of you probably know this little tool already:

    http://www.hquotes.com/tradehard/simulator.html

  32. Posted by tradernovice on September 8, 2006 at 10:53 am

    As SteveJ infers, R is relative to each trader’s individual trading plan. It is useful for determining each individual’s success against his (her) individual trading plan.

  33. Posted by Alaskan Pete on September 8, 2006 at 1:53 pm

    This whole “controversy” seems a little overdone. I’d guess the people arguing against reporting R values are either amateurs, or long term investors. Every short term trader I know who made it past the 2-3 yr survival mark thinks in terms of R value and most of them use a fixed % of account equity (some vary it according to perceived “strength” or “grade” of the setup). Additionally, many traders run into problems because they focus on the dollars and not on the trade. Thinking (and acting) in terms of R helps on the psychological end of applying discipline and trading free from emotion.

    Most traders have the “money management epiphany” sometime in their first year or two of trading. The shift in mindset from being right/wrong to a bet-placing at +EV points is reflected in this controversy.

    As many have already said, R values normalize results across account sizes. And given that most traders use some variation of a fixed % risk per trade, it is a very concise way to convey a trader’s performance. It would be a little vague if a trader radically varied their dollars at risk from trade to trade, risking 0.5% on one, 2% on another, etc. In a trading style like that, adding other data would paint a clearer picture.

    But in Mike’s case this seems unneccesary and frankly a waste of his time since a simple R values conveys his performance very well. Why spent 3 times as long adding data?

  34. Posted by Alaskan Pete on September 8, 2006 at 2:13 pm

    To me, this whole “controversy” seems a little overdone. I’d guess the people arguing against reporting R values are either amateurs, or long term investors. Every short term trader I know who made it past the 2-3 yr survival mark thinks in terms of R value and most of them use a fixed % of account equity (some vary it according to perceived “strength” or “grade” of the setup). Additionally, many traders run into problems because they focus on the dollars and not on the trade. Thinking (and acting) in terms of R helps on the psychological end of applying discipline and trading free from emotion.

    Most traders have the “money management epiphany” sometime in their first year or two of trading. The shift in mindset from being right/wrong to a bet-placing at +EV points is reflected in this controversy.

    As many have already said, R values normalize results across account sizes. And given that most traders use some variation of a fixed % risk per trade, it is a very concise way to convey a trader’s performance. It would be a little vague if a trader radically varied their dollars at risk from trade to trade, risking 0.5% on one, 2% on another, etc. In a trading style like that, adding other data would paint a clearer picture.

    But in Mike’s case this seems unneccesary and frankly a waste of his time since a simple R values conveys his performance very well. Why spent 3 times as long adding data?

  35. Posted by Alaskan Pete on September 8, 2006 at 2:15 pm

    This whole “controversy” seems a little overdone. I would guess the people arguing against reporting R values are either amateurs, or long term investors. Every short term trader I know who made it past the 2-3 yr survival mark thinks in terms of R value and most of them use a fixed % of account equity (some vary it according to perceived “strength” or “grade” of the setup). Additionally, many traders run into problems because they focus on the dollars and not on the trade. Thinking (and acting) in terms of R helps on the psychological end of applying discipline and trading free from emotion.

    Most traders have the “money management epiphany” sometime in their first year or two of trading. The shift in mindset from being right/wrong to a bet-placing at +EV points is reflected in this controversy.

    As many have already said, R values normalize results across account sizes. And given that most traders use some variation of a fixed % risk per trade, it is a very concise way to convey a trader’s performance. It would be a little vague if a trader radically varied their dollars at risk from trade to trade, risking 0.5% on one, 2% on another, etc. In a trading style like that, adding other data would paint a clearer picture.

    But in Mike’s case this seems unneccesary and frankly a waste of his time since a simple R values conveys his performance very well. Why spent 3 times as long adding data?

  36. Posted by JimC on September 8, 2006 at 3:47 pm

    I appreciate all the thoughtful discussion on this topic. To me, using R to manage risk is fine, but using it to measure performance doesn’t make sense. If you’re trading to make money (as opposed to trading for the thrill of it or any other reason), then the amount you make is the only value that matters in terms of keeping score. Report it as a percentage gain if you don’t want to share your portfolio size.

    The suggestion that other metrics such as win/loss ratio are good indicators of success doesn’t make any sense to me. If trader A has a system in which 60% of his trades are losers, but the winners are so much larger that he makes a lot of money, and trader B has 60% winning trades, but loses money overall, who is a more successful trader?

    Another problem I have with using R to measure performance is that it ignores the slippage you’re bound to encounter when you actually exit a position. Sure, you may set your stop loss at $25.50, but maybe you get filled at $25.45. Or, the stock gaps down several dollars a share, blowing way past your stop loss point (like PNRA the other day, closed at $54.75, opened the next day at $51.50 – what actual R value would you have gotten on that trade?).

    Good risk management is a prerequisite to successful trading, and if your risk management system is based on R, that’s fine. But at the end of the day, week, month, or year, I want to know how much more money I have than I did at the beginning, not how many times larger my gain was than a theoretical loss I didn’t actually incur.

  37. Posted by boots on September 9, 2006 at 5:30 pm

    The traders arguing against the use of R must have a different concept of R than I do, otherwise I can’t understand the complaints. Not only is it a good tool for trading but it is a Great tool for conyeying to others how you are doing.

    If I tell you I just made $1,000 on a trade you have no idea if that was a good trade or smart trade or how it compares to your own trading. I may have bought $100,000 worth of stock to make that $1,000. If I did risk $100,000 on the trade then the profit was .01R, not a very good trade.

    But if I tell you .01R then you immediately know the trade was not very succesful and you can also immediately relate it to your trading without doing any math at all. If you want to, multiply .01 times your own R. If your own R is $500 then in comparison you would have made $5. But that isn’t even necessary.

    It is also the best way I know for a trader to talk about how he is doing without telling everybody his account size. I think everybody has a right to keep that to themselves if they want, especially since it makes no difference.

    boots

  38. Posted by Chris Sauer on September 14, 2006 at 3:31 pm

    Hey I enjoy your blog and this particular post is excellent. I thought it was interesting the perspective Dehtrader gave as I have recently for better or for worse have an insight to share on this comparison of dollar amounts versus R units. I am not a very good trader yet and you will see why, but without using risk units I wouldn’t have found how impartant INACTIVITY is:

    http://stockdaytrading.blogspot.com/2006/09/risk-units-vs-dollars.html

Trackbacks

  1. […] TraderMike has a post on R-Multiples. […]

  2. […] TraderMike had a good piece on the debate over R-multiples. Van Tharp defines ‘R’ simply as “the risk you have in a trade.” […]