There seems to be a lot of controversial over the concept of R-Multiples. I?ve been seeing people complain about them for months now and I?ve been meaning to write a post about ?R?. I really wanted to do it last week but I?m glad I didn?t get to it because this week a raging debate about R has popped up. Glenn, at DehTrader can serve as the poster child for the anti-R crew. Here?s part of his recent rant against R-Multiples (emphasis is mine):

I post real numbers as opposed to R values, I always have. I like real numbers, I understand real numbers and I see truth in real numbers and I think the reader does too. As a reader of many blogs I find zero value in any post or summaries containing R values, I don?t see any point in sharing that information. I suppose if I posted in R values I could look like a pretty good trader, but we all know I am a struggling trader. R can mean anything so why even bother with it? R stands for bullsh!t imo and that?s my rant (that and ads haha). The best blogs out there post real numbers, Boogtser, JC (NYSE), the Kirkster all come to mind.

He?s joined by folks like Paul who left this comment over on Ugly?s post about R multiples:

I believe dollar values are more important than R value. I agree that the actual $ value is meaningless. However, R values are subjective and don?t give you a true idea on how successful the trade was. If you defined your risk at 15 cents and made 30 cents on the trade, while another person made 50 cents but decided his risk would be 50 cents, R values would say the guy who made 30 cents was more successful. I have a problem with that. It could very well be that the guy who only risked 15 cents is playing it too safe and his 2R gain was a bad trade.

So that gives you an idea of the anti-R sentiment. I?m going to explain why I think R-Multiples are so useful and why I use them in my trading and on this site.

What is R?

R is simply the dollar risk per trade. It?s nothing but a reward-to-risk ratio. I first heard it called ?R? in Van Tharp?s book ?Trade Your Way to Financial Freedom?. In another of his books, ?Financial Freedom Through Electronic Day Trading?, Dr. Tharp reveals the great secret of trading:

The golden rule of trading is to keep losses at a level of 1 R as often as possible and to make profits that are high-R multiples.

You often hear (read) that traders should only look for trades with a reward/risk ratio of at least 2 or 3 to 1. Expressing your results in terms of how many times your risk allows you to easily see how well your trades measure up to such a standard. So when I look at my results in terms of multiples of R I can easily tell how good or bad the trades were. I like to think of R-Multiples as telling you the efficiency of your system.

So why not just use dollars?

Expressing my results in dollars would achieve the same result if I always risked the same amount of money. But what if I triple my account and therefore trade larger positions compared to when I started trading? Or what if I hit a rough spot and decide to cut my share size down while I ride out the storm? Then the dollar results won?t easily tell me how trades from one period of time compared to another period of time. But if I use R making such comparisons is simple. Either my trades passed the risk / reward ratio test or they didn?t. The actual number of dollars at risk doesn?t matter, how many multiples of the dollars at risk does.

Along the same lines, recording trades in terms of R-Multiples allows you to easily calculate your system?s expectancy. (Follow the link for why you should care about expectancy.)

Also, as Rx said:

talking and thinking in terms of R-multiple when you discuss about profits is an excellent approach - that by itself makes you focus on risk and money management - the actual ?grail? to successful trading.

That is a very important point. Whenever I see people posting dollar returns, especially losses, that are all over the place the first thing I ask myself is ?I wonder what his risk per trade is?. It?s almost a certainty that those traders aren?t focusing on risk and as a result keep having huge losses. The mere fact that you have to define R and then place a stop to keep your loss to 1R is probably too constraining for those gamblers traders. Dr. Tharp says about determining your initial stop-loss point as soon as you enter a trade, which, by definition woud give you a 1 R loss:

This principle is so important that if you cannot follow it, then you might as well give up the idea of electronic day trading right away.

The reason I use R on the blog is because I don?t want to discuss dollars or my account size on the site (as Ugly stated). That?s nobody?s business but mine. Also, it makes it easy for people to figure out what they could have made or lost on a trade with their own account size and risk per trade amount. If you see a trade that returned 3R all one has to do is plug in their dollar risk per trade to figure out what they could have made / lost.

To the R Haters

Let me address the ?alleged? issues which I quoted above?

Glenn thinks that R is just some made up number and could mean anything. He likes ?real? numbers. While it may be fun to see that somebody made $10,000 on a trade that in and of itself doesn?t tell you how good that trade was. What if that person risked $30,000 to make that $10,000? Or what if they risked $1,000 to make that $10,000? Those are two very different trades. Sure they both made the same amount of money but isn?t the second trade a much more efficient use of capital?

What if somebody is trading $500,000 lots to make $1,000 in profit? It may be nice to see somebody saying that they made $1,000 here and $1,000 there but damn(!) that?s an inefficient use of capital. So while R could mean anything in terms of dollars, in my humble opinion what really matters is how many multiples of R were made or lost. That tells you the quality of a trade or system.

Glenn also states that if he reported his trades in terms of R he could appear to be a good trader. I?m sorry to tell him that?s simply not the case. If you lost money that means your expectancy, which is just your average return expressed in R-Multiples, was negative.

Paul said that ?R values are subjective and don?t give you a true idea on how successful the trade was?. That is exactly wrong. R-multiples are the very thing that tells you exactly how successful a given trade was, if you choose to grade on a risk/reward basis.

Percentages vs. Dollars

This debate about R reminds me of a conversation I had a couple of weeks ago. I was in a presentation for Trade-Ideas? new tool, the Odds Maker. They were showing how you could backtest all these different scenarios with the tool. The results were expressed in average dollars won or lost. Another viewer and I asked about seeing the results in percentages. They kept saying that perhaps they would do that in a later revision. I kept harping on it because to me seeing the results in dollars was of little use for the way I size my positions

The argument from the presenter was that all you had to do was multiply the average dollar return by your average lot size to figure out how much money you could have made with a given system you were testing. I had to disagree because my lot size can vary drastically depending on how far away my stop loss is. Here?s a situation which could be problematic ? I trade Google with a 2 point stop (which is only about half of a percent) and get lucky and make 6 points of profit. All of my other trades are on stocks under $50 with stops less than 50 cents. I could have some combination of winners and losers mixed in there? most of them probably well less than $6. That $6 gain may skew the results when presented as average dollars won. That?s an over-simplification and there are all kinds of possible permutations. But I hope my point is clear that looking at the results in terms of average dollars won/lost may not tell accurately tell you the story.

So how can we make the results clearer? Simple, express them in percentages. That way, regardless of how many shares were traded or the prices of the stocks traded the results can be equalized across all the trades. I feel much better being able to say , ?OK, this system would have returned X%? instead of ?X number of points.

We debated the merits of each way of reporting for a few minutes and at one point somebody said, well , for this release we?re aiming for the ?lowest common denominator?. In other words, the average person can?t think in percentages, so we?re just gonna report in points. I was like, F the average person, make it work the ?right? way! The funny thing is that after debating all of that the software actually could express the results in percentage terms. We just had to switch a setting.

So my point of that little story is that I always prefer to think in terms of percentages in stead of points. I always see people talking about number of shares of point moves. For example, you might hear somebody exclaim ?Google is up 5 points!!!? I don?t see that as anything to get excited about. That just over a 1% move ? a normal fluctuation. You?ll hear similar things from reporters talking excitedly about the Dow being up some triple-digit amount. The Nasdaq may actually be up a lot more on a percentage basis but they?ll just say, eh, the Nasdaq is ?just? up 30 points.

Looking at the percentages makes those kind of comparisons easier. R-Multiples do the same thing for traders. They can accurately compare their own trades and they can take another trader?s results expressed in R and easily relate them to their own system.