One of the basic tenants of risk management is thinking in terms of risk multiples or “R-Multiples”.
The term “R-multiple” was coined by Dr Van Tharp and it’s important that you not only grasp his concept, but you think in terms of it.
If you are thinking of your trade in terms of R-multiples, you might say “I had a 3R trade”, rather than “I made $300”.
To calculate your R-multiple, take the distance between your entry and your stop. This is 1R (1 x risk). For example, if your stop was 100 pips away, your 1R is 100 pips. If you make 300 pips on the trade, then you have made 3R.
It’s a simple and effective method for measuring your risk.
But the real benefit of thinking in terms of R-multiples is psychological.
As a trader, it is all too easy for your decision-making to be influenced by your account balance or the size of your position. When there is too great a focus on money, traders do all sorts of silly things.
Instead, you can view your trades as a series of R-multiples. This is called an R-multiple distribution. For example, a series of 15 trades from a trading system might look like this in terms of R:
1.5, -1, -1, 2.8, -1, 0.3, 1.1, -0.3, 1.4, 0.7, 0.5, 2.7, 0.8, -0.2, -1
From this sample of trades, the system has made 7.3R in profit, with an expectancy of 0.48 and a win rate of 60%. If a system can achieve something like this repeatedly, then many traders can use position sizing to achieve their trading objectives.
A game of probabilities
We can mentally treat our trading as a game that produces not pips or dollars, but R-multiples. If we play the game long enough, we don’t need to concern ourselves with the result of any one trade or loss.
You can simply let the probabilities play out and your position sizing model can manage the achievement of our trading objectives.
It’s not about money
We de-personalize our system by thinking of it in terms of probabilities. It is simply there—not to win or lose—but to generate R-multiples. When you do this, it is important not to interfere with our trading system, but to let it run so it can produce the necessary R-multiples.
Thinking in terms of R creates mental space. You separate the role of your entries and exits in your trading system from the amount you risk. If you think “I am going to risk $1000 on this trade” and it is too much for you, then you will freak out.
It’s much better to observe your entry in an impartial manner (oh, I see an entry; I will enter now) and think, I am going to risk 1R on this trade (which is whatever dollar amount the position sizing model says it’s to be). Then, let go of the outcome and manage the trade per your rules and it will produce an R-multiple out of the distribution series—and it doesn’t matter which one.
By thinking like this, I only fail if I break my rules, as that will break my R-multiple distribution, which will break my position sizing model, which will mean my trading system is not going to achieve my objectives.
Over to you…
Stop trying to predict the market and simply accept what it provides you in terms of R.
This can be quite freeing as a trader—you should try it.
About the Author
Sam Eder is a currency trader and author of The Consistent Trader and the Advanced Forex Course for Smart Traders (get free access). He is the owner of www.fxrenew.com a provider of Forex signals from ex-bank and industry traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter or get FREE access to his acclaimed How to Be a More Consistent Trader Short Course.