R: one unit of risk
After this lesson you can state the outcome of any trade in R, and compare two trades of completely different sizes on equal footing.
Give the loss a name
The last lesson ended with a number: how much a single losing trade is allowed to cost you. That number is important enough to deserve a short name, so from here on we call it R.
R is an amount of money, and you choose it. If your account is €10,000 and you've decided a losing trade may cost you 1% of it, then R = €100. Every trade you take risks one R. When a trade loses, it should lose €100, give or take a little slippage. When it wins, you measure the win against the same yardstick.
Say you buy a stock at €40 and your stop sits at €38. (The stop is the exit you decide in advance; course 5 makes a whole lesson of it.) Being wrong costs €2 per share. With R = €100 you buy 50 shares, because 50 × €2 = €100. Now look at the possible outcomes:
- The stop is hit at €38. You lose 50 × €2 = €100. That's −1R.
- You sell at €46. You make 50 × €6 = €300. That's +3R.
- You sell at €41. You make €50. That's +0.5R.
Results written this way are called R-multiples, a way of thinking that Van K. Tharp spent his career teaching. The outcome of a trade is expressed as a multiple of what you risked to get it.
Why measure in R
Suppose a friend tells you they made €800 on a trade last week. That sounds fine until you hear the other number: they were risking €2,000 to make it. In R-language the trade is +0.4R. They put €2,000 on the table for an €800 payoff, and if that's what their trades usually look like, one normal losing streak from course 1 takes back weeks of wins.
Euro results mix two things that need to stay separate: how good the trade was and how big it was. R strips out the size. A +2R trade is a +2R trade whether the account is €5,000 or €5 million. That lets you compare your trades to each other honestly, and later, in course 4, it lets you compute what your trading actually earns per trade.
There's one more effect, quieter but maybe the most valuable. When you lose exactly 1R, nothing went wrong. You planned to pay €100 to find out whether the trade would work, it didn't work, and you paid the agreed price. The loss that should bother you is the −2.3R in the journal, because somewhere along the way the plan got rewritten. Course 5 is about how that happens.
A month in R
Here is a made-up but realistic month of ten trades, written the way your journal will write them:
| Trade | Result |
|---|---|
| 1 | −1R |
| 2 | −1R |
| 3 | +2.5R |
| 4 | −1R |
| 5 | +1R |
| 6 | −1R |
| 7 | −1R |
| 8 | +4R |
| 9 | −1R |
| 10 | −1R |
Seven losers, three winners, and the month adds up to +0.5R. It's worth pausing on: this trader was wrong seven times out of ten and finished ahead. Every loss is the same size, which is what the discipline looks like once it reaches the page, and two decent winners carried everything else. The same month written out in euros, with the sizes varying from trade to trade, would take real work to read. In R you can see at a glance that the method survived and that the trader kept the contract.
Check yourself
- Account €20,000, risk per trade 0.5%. What is R? (€100.)
- You risked €250 on a trade and closed it for a €625 profit. Result in R? (+2.5R.)
- Your journal shows a −2.4R loss. What question should you ask about that trade? (How the loss got past 1R — did the stop get moved, or did price gap through it? Gaps are course 6.)
The habit this lesson installs
A loss of exactly 1R means the plan worked.
Next: Course 3 — "Position sizing: a short division problem." (Attribution: R-multiples as a teaching device are Van K. Tharp's.)