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Trading Foundations part 1:
The ONE number you need to know for every trade you make.
//Thread//
2/n Today we will talk about R - risk per trade.
It's not a sexy concept...
But you have to understand it if you want to answer more sexy questions like
"How much money can a trader make?"
So let's Go!
It's not a sexy concept...
But you have to understand it if you want to answer more sexy questions like
"How much money can a trader make?"
So let's Go!
3/n
Everyone says "risk management is the key to profitable trading"
While I don't agree (more on this later), it is still important to understand how traders measure risk.
You will often hear traders refer to "R".
R is the amount of capital you risk on a given trade.
Everyone says "risk management is the key to profitable trading"
While I don't agree (more on this later), it is still important to understand how traders measure risk.
You will often hear traders refer to "R".
R is the amount of capital you risk on a given trade.
4/n
R is not your total position size - it is your RISK: the amount you are willing to lose.
the formula is:
R = (Entry Price - Stop Price) x (# of shares)
R is not your total position size - it is your RISK: the amount you are willing to lose.
the formula is:
R = (Entry Price - Stop Price) x (# of shares)
5/n
Say you buy 100 shares of stock at $10.
Position size = $1000
You set a stop-loss at $9, so if the price goes below that, you exit the trade for a 1 dollar loss per share.
Since you have 100 shares, your potential loss is 100 dollars.
R = $100.
Say you buy 100 shares of stock at $10.
Position size = $1000
You set a stop-loss at $9, so if the price goes below that, you exit the trade for a 1 dollar loss per share.
Since you have 100 shares, your potential loss is 100 dollars.
R = $100.
6/n
Why use R?
Simple - imagine you see a good trade setup in $AAPL.
Now you are faced with a question: How many shares should you buy?
Assuming you have a good strategy, the answer to this question is the difference between getting rich and going broke over the long term.
Why use R?
Simple - imagine you see a good trade setup in $AAPL.
Now you are faced with a question: How many shares should you buy?
Assuming you have a good strategy, the answer to this question is the difference between getting rich and going broke over the long term.
7/n
Buy too many shares and the wild swings will decimate your account. (and your mental game)
Tew few?
You will never grow.
Buy too many shares and the wild swings will decimate your account. (and your mental game)
Tew few?
You will never grow.
8/n
R provides an easy way to measure this.
Traders like to set R to a certain % of their trading account, usually somewhere between 1-5% per trade.
This allows you to adjust your total position size based on the market you are trading.
R provides an easy way to measure this.
Traders like to set R to a certain % of their trading account, usually somewhere between 1-5% per trade.
This allows you to adjust your total position size based on the market you are trading.
9/n
In the example above, you bought 100 shares with a stop of 1 dollar, risking 100 dollars.
But what if the market was more volatile, and the stop was two dollars below entry?
To keep R at 100 dollars, you only need to buy 50 shares.
But won't you make less???
In the example above, you bought 100 shares with a stop of 1 dollar, risking 100 dollars.
But what if the market was more volatile, and the stop was two dollars below entry?
To keep R at 100 dollars, you only need to buy 50 shares.
But won't you make less???
10/n
No.
In general, when the market is more volatile - you can expect more movement on the upside as well.
So I would set my profit target at 16 dollars instead of 13, and still, end up with the same 3R trade, and still make the same 300 dollars if I win, (or -100 if I lose.)
No.
In general, when the market is more volatile - you can expect more movement on the upside as well.
So I would set my profit target at 16 dollars instead of 13, and still, end up with the same 3R trade, and still make the same 300 dollars if I win, (or -100 if I lose.)
11/n
Using R, I can compare my trading across different assets and different strategies, using one number.
I like to ask - "How many R has this strategy made in a given period of time?"
Imagine a trader tells you he made 10,0000 dollars trading last year. Is he a good trader?
Using R, I can compare my trading across different assets and different strategies, using one number.
I like to ask - "How many R has this strategy made in a given period of time?"
Imagine a trader tells you he made 10,0000 dollars trading last year. Is he a good trader?
12/n
Maybe he is, maybe he isn't.
How much did he risk?
What was his starting capital?
But he tells you he made 200 R last year?
Yes - he is good. (or lying. But traders never exaggerate profits
)
Maybe he is, maybe he isn't.
How much did he risk?
What was his starting capital?
But he tells you he made 200 R last year?
Yes - he is good. (or lying. But traders never exaggerate profits
)
13/n
So what should your R be?
This is a topic that whole books could be written on and it depends on the statistics of your strategy...
...but as a rule of thumb, many people recommend a 1% max risk per trade.
So if you have a $10k account, an R of $100 dollars is good.
So what should your R be?
This is a topic that whole books could be written on and it depends on the statistics of your strategy...
...but as a rule of thumb, many people recommend a 1% max risk per trade.
So if you have a $10k account, an R of $100 dollars is good.
14/n
To really really answer this question, we can turn to Monte Carlo simulations - in an upcoming blog post I'll do just that.
(Hit the link in bio to get on my email list if you don't want to miss that)
To really really answer this question, we can turn to Monte Carlo simulations - in an upcoming blog post I'll do just that.
(Hit the link in bio to get on my email list if you don't want to miss that
)
15/n
Bonus: One more thing to know about R...
Stops are never guaranteed - you can lose way more than 1 R if the market gaps down overnight.
Testing this over one of my strategies, I saw a real-world loss of 1.05 R.
The golden rule of trading: Shit happens.
Bonus: One more thing to know about R...
Stops are never guaranteed - you can lose way more than 1 R if the market gaps down overnight.
Testing this over one of my strategies, I saw a real-world loss of 1.05 R.
The golden rule of trading: Shit happens.
16/n
This was thread 1 in my trading foundations series. Follow to see the rest, or jump on my newsletter to get them in your inbox (link in bio).
This was thread 1 in my trading foundations series. Follow to see the rest, or jump on my newsletter to get them in your inbox (link in bio).
