How to Use R-Multiple Trading to Analyze Risk

January 19, 2023
Weekly Trading Insights

How do professional traders analyze risk?

The simple answer: R-Multiple.

Ah, the R-Multiple - often one of the most overlooked and misunderstood trading metrics. 📊

(It doesn’t have to be that way, though.)

We did a deep dive into understanding R and R-Multiple a while back. For a full look at R-Multiple check that out.

But feel free to get started here first 🙂

How does R-Multiple Trading work?

If that’s still confusing, here's a breakdown of how R-Multiple Trading works:

⚪ You risked $1 on a trade and made $2 in reward.

That’s a 2R trade. ✅

⚪ You risked $1 on a trade and expect to make $2 in reward but you lost $3 instead. Oof!

That’s a -3R trade. 🤡

⚪ You risked $1 on a trade and made $1 in reward.

That’s a 1R trade. 👍

Get the picture? 🤓

While of course there’s MUCH more to it than that, we’ll spare you the details for now.

The question is, how can we derive meaning from this R-Multiple number?

There’s quite a few pieces of insight that you can learn when analyzing your R-Multiple. 🤓

◼️ Stop loss discipline

◼️ Long-term profitability

◼️ Strength of strategy

Let’s dive into an example:

You buy 100 shares of SPY at the 400 key level. You set your stop-loss at 399. Your profit target (where you expect to exit for a gain) is 402.

➡️ Entry: 400

❌ Stop loss: 398

🎯 Profit target: 406

If we were to say this aloud, you’re risking 1 point ($100 in this scenario) to catch 2 points ($200 in potential profit).

$200/$100 = a 2R potential trade.

Let’s say that price immediately moves against you.

It’s gone to 399.

According to your plan, you should be closing the trade...😌

If you were to exit for a loss here it would be a -1R trade.

You’d have followed your stop loss and can move on to the next trade.

But, you continue holding in hopes of a move higher. 🤞

(Where’s that clown emoji?)

You can see where this is going… 😅

Now it’s at 398.50, and 398. You exit at 398 for a larger loss than you had planned. 😒

You've risked 2 points here instead of 1. That makes for a -2R trade.

What happened? That’s a lot different than the +2R trade you had planned out!

What can we learn from this? 🤔

Well…we can understand that any trade that goes beyond a -1R means that you didn’t follow your stop loss.

Here's a guide:

2R and above... Great! 💰

1R... In the green. 🟢

0R... You broke even. ⚪

-1R... You exited at your stop loss. ️✔️

Below -1R... You held past your stop loss. 🤡

Now we know our first mistake. 📝

🔀 Let’s change the scenario a bit and say that we decided to exit for profit at 401 instead of 402.

This means that we took a 1R trade, because we risked $1 to make $1.

Two things:

1. Your planned R-Multiple was 2R, but your realized R-multiple was 1R. 📝

If this is consistent across most of your trades, it’s highly likely that your mistakes lie in not letting your winners run. 💸

TradeZella’s Trading 101: Risk, Reward and Win Rate table for R-Multiple Trading
Risk vs. Reward in Trading

2. This might sound good because you made some money, but doing this consistently over time would mean that you would need to have a much higher win rate (60% and above). ✔️

See the table.

If you see that you can’t seem to get into trades that produce a 2R, it’s possible that your strategy needs to be refined. 🔨

Perhaps you need to find a strategy that works better for you to be able to catch more explosive moves. 🚀

These are just a few of the amazing things you can learn from R-Multiple in trading.

If this sounds interesting to you... check out our Definitive Guide to Understanding R and R-Multiple blog post here for an in-depth look at how to identify patterns and set targets so you can have a grip on your R-Multiple!

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