“The truth is that, while you can’t quantify reward, you can quantify risk.” – Larry Hite
Good traders don’t talk about the money they make in the markets.
Not because it’s crass to talk about (though it can be), but because it’s not what they are thinking about when they trade.
To the good trader, money is the by-product of successfully following their trading processes.
And instead of thinking about money, they think in terms of risk/reward, which brings us to Risk multiples (R-multiples).
What are R-Multiples?
R-multiples are a concept developed by Van Tharp (a trading coach), in order to quantify the amount you will win or lose in terms of risk/reward.
It’s actually not. The initial R-multiple is simply the distance between your entry and your stop loss. For example if you stop-loss is 30 pips away from your entry then 30 pips is your 1R, or one times your risk.
If you then make 90 pips on the trade you will have made 3R or three times your risk. If you made 60 pips you would have made 2R.
A good trader who thinks in terms of risk/reward might finish the day’s trading and say “I made 3R on my trade today”.
The power of the R-multiple
You can make an R-multiple whatever dollar value you want it to be by adjusting your position size. This is what makes it such a valuable concept.
For example you can, make that 30 pip loss worth $30, $300 or $3000, or you can make it worth a percentage of your account, simply by adjusting the position size.
This means that you can keep your risk constant when you trade. For Example if you have a position with a stop-loss of 50 pips you can adjust the position size so that you are risking the same dollar amount as when you were risking 30 pips.
Then you would have to make 150 pips to earn 3R on the trade, instead of 90 pips, but your dollar amount risked would remain the same.
You must master these concepts if you are serious about trading
You don’t need to have a Ph.D. in statistics to be a good trader.
But you do need to master basic concepts around risk/reward if you want to trade well.
So take some time to practice and apply what you have learned here, and your trading account will thank you.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a key team member at premium FX services provider www.fxww.com and part owner of Forex Signal Provider www.fxrenew.com (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free: https://fxrenew.com/newsletter-sign-up.
This post was first published here.