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After being popularized in Trade Your Way to Financial Freedom by Van K. Tharp, ‘R’ has been adopted as a way to communicate the performance of a trade. If it is new terminology to you, I’ll explain: R is the standardize expression of risk to reward.
It is always equal to the entry minus the stop loss per contract (or share). That is, the per unit of risk one took to enter a trade. So for example, a trade where 1 point is risked per futures contract and 5 points are gained (after the trade is closed) will have an R of 5.
Recently a comment was left on Eyal’s blog in which his use of R was called ‘meaningless’. The person who left the comment said that they would prefer to see dollars instead of ‘R’. Sharkey made a great effort to explain why this was a baseless argument. Even though his explanation was wonderful, it lacked something important. That’s why I wanted to add that little bit because I think it should make it clear why using R is superior to using dollars.
Think about what underlies each and every trade. Or put another way, what is the fundamental responsibility of each trader? Simple: to mitigate and benefit from risk.
Of course, one can never totally eliminate risk - otherwise there is no trade. But the point is that as a trader, managing risk is your number one priority. It should be, unless you want to have a really short trading career. So in a sense, you could say that risk is the traders ‘currency’.
Just as a dollar is a quantified and standardized amount of ’something’, in the same way R is a quantified and standardized amount of risk. But since we are talking about trading R is much more important than dollars. This is because: Dollars don’t matter in trading - risk does. If you don’t believe that, then put on a trade with zero consideration for risk and then come and tell me about it. By constantly using R, a trader disciplines their mind to think in terms of risk.
Also, if you compare your trades with a friend’s using dollars, you are comparing apples and oranges. This is because you are not taking into account different markets, trading methods, portfolio sizes, and many other considerations. But by using R you can effectively compare across all of those differences by standardizing performance according to the risk that was undertaken to achieve it.
Hopefully the above has been helpful in understanding why R is such a fundamental concept and why it is superior to dollars. Always remember the central role of risk and the trader’s relationship with it and you’ll naturally come to use R yourself.
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