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I took my first trade in months this past Thursday. I have been slowly trying to get back into the forex market by cautiously watching the GBP/USD. It's been a while since I followed any currency pair so I wanted to be sure that I watched the GBP/USD for a couple of days before taking any trade. I've decided to start referring to my profits/losses in terms of expectancy. Expectancy is "simply the mean or average R-multiple generated." (Source:http://www.iitm.com/sm-Expectancy.htm)
The "R" in R-multiple is short for risk. The best way to understand it is to either read the source above or continue reading. Let's take my first trade as an example. I knew my total dollar risk before entering the trade, that amount being $650.94. (yes, that exact) I exited half of my position when I had profited $329. I moved my stop to breakeven on the remaining position. Unfortunately I was stopped out on the rest giving me a total profit of $329. To figure out the R-multiple, you would take (profit / amount risked) which in this case was $329/$650.94 = .5R. Ideally, the higher the R in a profit situation, the better. For instance, a 2R multiple would be obtained in a 2:1 reward/risk trade and a 3R multiple in a 3:1 reward/risk trade. In a loss situation, a higher R is actually worse. Ideally, if you lose on a trade, the R-multiple should be 1R or less. If it's 1R, it simply means that you lost the amount you were expecting to risk. So in my above example, if I lost $650.94 on the entire trade, my R-multiple would have been 1R. Let's just say that I got stupid and decided to stay in the position and not honor my stop loss setting. Because of this stupidity, let's also say that I wound up losing $1301.88, twice as much as my initial risk. Calculating using (loss / amount risked) I would have an R-multiple of $1301.88/$650.94 = 2R.
So what does all of this mean? Well, I only have 1 trade to calculate my expectancy which would currently be .5R. I'll get more into calculating mean expectancy once I've compiled more trades. But having .5R isn't desirable because it basically means that I risked twice as much as the reward I obtained. This is exactly why I want to try to use R-multiple when I talk about my trades because even though I had a $329 profit on my first trade, it isn't as rosy as it may seem. The R-multiple was only a .5R and although it was profitable, if I trade this way in the long haul, I'll surely lose.
Another good source that also mentions the critics of R-multiple can be found at http://tradermike.net/2006/09/r_r-multiples_defined/
R
forex blog
money management
october 2007
r-multiple
reward
risk
That is a little miss leading. Just because your r is .5R does not mean that you will lose on the long haul. It really only matters on what your success rate is. If 3 of your 4 trades are successful .5r will still make you money. if it is a 1 to 1 then you have a problem. The R multiple dosen't spell success or failure by its self. I don't agree. .5R may still make me money if my system wins 75% of the time but this is very unlikely. Let's just say that realistically, my system wins 40% of the time. 4 winners return .5R or a total of 2R. The 6 losers produce 1R. That's a total of 6R. The expectancy would therefore be 2R-6R/10 or -.4R. Get a negative expectancy and I'm a loser. |
