Thursday, September 7th, 2006
Keeping things, R, simple
TraderMike had a good piece on the debate over R-multiples. Van Tharp defines ‘R’ simply as “the risk you have in a trade.”
I agree with using ‘R’ because it allows risk/reward ratios to be compared when portfolio size changes.
For example, if you have a $100,000 account and want to risk 2% of it in a trade, then R = $2000. If the trade pays off and you make 6%, then you’ve made $6000, or 3 times R (3R).
Now assume the account has increased to $150,000, but you still want to risk 2 per cent, or $3000 in this case. This time you make 4 per cent, or $6000 - the same amount as the first trade.
However, in the second trade you’ve only made 2R, so your risk/reward ratio has fallen from 1-3 to 1-2. So despite making the same amount, the second trade is not as good.
From this example, you can see that using R-multiples simplifies the exercise of comparing trades.
Word Count: 161. This entry was posted on Thursday, September 7th, 2006 at 7:54 pm and is filed under Risk management, Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
