The Difference Between R-Multiple And Reward:Risk
The concept of ‘R’ or ‘R-multiple’ is popular among traders and the Edgewonk trading journal also uses this metric repeatedly in different ways. It is similar to the conventionally used Reward:Risk ratio with a few distinct differences.
This is a straight forward 4 steps process:
- You evaluate the potential price levels for your the stop loss and take profit
- Measure the distance between your entry and your stop loss = Potential Risk
- Meausre the distance between your entry and your take profit = Potential Reward
- You devide the two: Potential Reward / Potential Risk
This sounds more complicated than it is. Here is a screenshot that shows how you define the RRR for your trade:
Step one: Determining 1R
In short, “R” can be substituted for “Risk” and it measures the distance between the point of your trade entry and your stop loss order.
In the screenshot below, we are assuming that a trader entered a trade $113.40 with a stop loss order at $110.00. The distance between the entry and the stop is $3.40. Thus, the risk of the trade, in terms of “R”, is $3.40 – 1R = $3.40.
Step two: The trade potential in R-multiple
The next step is to determine the distance between the entry price and the target. In our case, the target is set at $124 and the distance between entry and target is $10.60 ($124.00 – $113.40).
Now, we can use the concept of R-multiple to describe the potential profit. We said that 1R equals $3.40 (the distance between entry and stop) and by dividing the potential profit by the $3.40 we get the R-multiple of the trade – if we divide $10.60/$3.40 we get 3.1.
This means that the R-multiple of the trade is 3.1, or that the potential profit is 3.1 times the potential loss for that trade.
Potential vs. actual performance
The real difference between the two figures lies in where they find their application. Whereas the Reward:Risk ratio (RRR from now on) is more of a potential performance metric that is measured when the trader enters the trade, the R-Multiple describes the actual performance of a trade when it is closed.
Comparing RRR and R-Multiple
Most traders only focus on the RRR they have when they open their trades, but they forget that the ratio changes throughout their trade. Edgewonk differs between the planned RRR (when you enter your trade) and the realized R-multiple (when you close your trade). By comparing these two metrics, along with performing other background calculations, Edgewonk provides very specific insights about your trading:
1) Expectancy and R-multiple
The concept of R can be used to filter out trades which have a negative expectancy. What does it mean? Let’s say you have a trade where your planned RRR is 1:1 – this means that a loss and profit would have the same size. Thus, you need a winrate of above 50% to end up making money because wins and losses have the same size. A trade where your planned RRR 2:1 (a profit is twice the size of a loss) only requires a winrate of 33% or higher – for every 2 trades you lose, you only need 1 winner to make up for the loss. Too much math? Hang in there and you’ll see that Edgewonk does all that for you.
A green “traffic light” in the trading journal indicates that the planned RRR of that trade is large enough. A red traffic light signals that the planned RRR is too low. By keeping your traffic lights green, a trader can significantly increase the way he picks his trades.
Furthermore, if you see a lot of trades where you first had a green light on the planned RRR and then it changed to red after closing the trade, it indicates that you have somehow mismanaged your trades and reduced the R-multiple.
Tip: You can also go to the Edgewonk simulator and filter your trades for different RRR numbers and then see how the simulations change. You’ll be surprised how those account graphs change.
2) Impacts of trade management on R-multiple
In the “Performance tables”, you can directly compare the planned RRR andthe finalized R-Multiple. If you se major deviations between the two, you should start investing further to find out what is causing those deviations.
For that, you can go to the Trade Management area in your Edgewonk journal and analyze how your trading behavior is impacting your performance overall and if you are leaving money on the table.