How to Use R-Multiple Trading to Analyze Risk
Author - TradeZella Team
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.
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. 💸
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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