Tuesday, September 15, 2015

Talking in terms of R - updated

Note: this post originally appeared in July 2014, and has been updated to reflect performance since then.

1R is the amount you risk on each trade. Profits or losses are calculated by taking the result and dividing by the initial risk. For example, if you risk £100 per trade, and you end up with a profit of £500, that's a +5R profit. If you lose £80, that's an -0.8R loss.

However much you risk on each trade will equate to 1R. Some traders stick to a fixed monetary amount to risk on each position, regardless of any fluctuations in the overall equity. The majority however calculate their risk per trade based on a percentage of their equity. So, if you risk £200 on a £10,000 account, or risk £2,000 on a £100,000 account, both equate to 2% of the equity, and both equate to 1R.

The trend followers that I know of, and the systems they use, tend to stick to a fixed percentage of equity per trade. Over the course of any trading history, in terms of monetary amounts the risk can substantially change. Some traders generally become more risk averse the longer they trade, or maybe due to position limits or a run of losing trades they may reduce the risk per trade (in percentage terms), but I do not know of any traders who would increase their risk as a result of any previous success - certainly among those who are still in the game.

Those who have read about the Turtle traders back in the 1980's will know that they used this approach, and tended to talk about trading results and risks purely in terms of R.

In addition to a cash equity curve, which most traders plot, I also keep track of my performance solely in terms of R. Both charts are shown here. Only closed trades are plotted.

Some points to note:

No one individual losing trade has caused a significant drawdown - the biggest loss in terms of R was -1.98R, and was a result of a gap down on earnings. In the sample of 351 trades in the period, there have been 5 occasions where the loss taken was bigger than -1R, and on all these trades it was due to an adverse reaction following an earnings release or trading update.

The big jumps are where trends held for a period of time have come to an end. The biggest winning trade was discussed here.

There has been a significant drawdowns incurred as a result of a run of losses. In this period, there have been three instances where there has been more than 10 consecutive losing trades. The first time, 11 consecutive losses accounted for a loss of -3.19R. On the second, -5.02R was taken by 12 consecutive losses. However, the largest drawdown was -17.72R, during the bad run of losing trades in the second half of 2014. In this period, I lost 38 trades out of 40.

Such horrible runs of losing trades can and do happen, even to those trades who have been consistently successful over many years. In Peter Brandt's Diary of a Professional Commodity Trader, the period of trading he was covering in the book immediately followed a such a run:

"Of a series of 27 trades during October and November, 24 were liquidated at a loss and only three at a profit". 

In both those cases, there were open trades which were in profit which negated at least some of those losses, but they are never taken into account until those trades are also closed.

My metrics show a total return of more than +170R, with a win rate around one in three, even with that horrible period last year. That can only be achieved by observing the time-honoured principles of cutting your losses short, and letting your profits run.


  1. so do you base your R risk as the percentage of distandce your stop is Or the amount of capital you have invested vs. total equity. So i am risking 2% in terms of stop distance, but have 7% invested in terms of equity balance, what do you consider to be yoru risk? the 7 % invested or the 2% stop distance?

  2. For me it is the risk distance of 2%, and I guess that is how most traders calculate it. The 2% of equity is what I am prepared to risk on a position. However with my stop methodology I try and reduce my risk as soon as possible by moving my stop closer to entry. However, there is always the possibility of a gap down, excessive slippage etc., meaning you can lose more than you risk.