One of the cardinal principles of trading that is good is to always have an exit point before you enter into a trade. This is your case risk for your trade. It is the point at something's wrong with this trade and I need to escape to preserve my capital.

Many sophistied traders are going to have some kind of exit criteria they like. If you're a newcomer and you just don't knowI'd recommend 75 percent of your entrance price if you're an equity trader. That is, if you buy a stock a $40, then get out if the stock drops to $30 or below. If you're a futures trader, then figure out the average true range throughout the last ten days. Then you must get out of the position, if the contract drops to that degree.

Your primary stop defines your initial risk. In the example of the $40 stock, your initial risk is $10 per share and that I call this risk 1R (where R stands for risk). And if you understand your riskyou may express all your results in terms of your risk.

So let us say your initial risk is $10 per share. If you make a profit of $40 per share, then you have a gain of 4R. If you have a reduction of $15 per share, then you have a 1.5R reduction. Whenever you have a sudden big move against you and losses will occur.

Let's look at a few more. What if the stock goes around $140, what is your profit in terms of R? Your profit is $100 and your risk is $10, and that means you've created a 10R profit.

It is quite interesting since portfolio managers like to speak about 10 baggers. By a 10-bagger mean a stock they purchased at $10 per share that goes around $100 -- in other words a stock that goes up in value 10 times. I feel a 10R gain in a whole lot more useful to consider and easier to attain.

If our 1R reduction was $10 per share, then the stock had to go up by $100 to receive a 10R gain. However, to match the portfolio manager's definition of a 10 bagger it might have had to go up 10 times the price you purchased it to get, moving to $400 from $40 per share. However, what would that $460 gain be in terms of R-multiples when your risk was $10? That's correct, it would be a 36R gain.

What I want you to do before next week is to have a look at all your closed trades annually and then express them as R-multiples. To put it differently, what is your risk? What was your entire gain and loss? What's the ratio of each profit/loss into the risk? And if you did not set your risk for your trades this past year, then make use of your reduction as a rough estimate of your risk.

Let's look at just how 10 trades may be expressed as ratios of the initial risk. Here we have $454, $1333, and three losses $567. The average loss is $785.67, so we'll assume that this is the initial risk. Hopefully, you'll understand the risk, and that means you won't have to use the reduction. I call the ratios that we calculate, the R-multiples for the trading platform. This information is shown in the table below.


Lt;table id=table125 align=center border=1 bordercolor=#333333 cellpadding=5 cellspacing=0gt; lt;tbodygt; lt;tr align=center valign=topgt; lt;thgt;Positionlt;/thgt; lt;thgt;Profit or Losslt;/thgt; lt;thgt;R-multiplelt;/thgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;1lt;/tdgt; lt;tdgt;$678lt;/tdgt; lt;tdgt;0.86Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;2lt;/tdgt; lt;tdgt;$3456lt;/tdgt; lt;tdgt;4.40Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;3lt;/tdgt; lt;tdgt;-LRB-$567)lt;/tdgt; lt;tdgt;- 0.72Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;4lt;/tdgt; lt;tdgt;$342lt;/tdgt; lt;tdgt;0.44Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;5lt;/tdgt; lt;tdgt;$1234lt;/tdgt; lt;tdgt;1.57Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;6lt;/tdgt; lt;tdgt;$888lt;/tdgt; lt;tdgt;1.13Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;7lt;/tdgt; lt;tdgt;-LRB-$1333)lt;/tdgt; lt;tdgt;-1.70Rlt;/tdgt; lt;/trgt; lt;tr align=center valign=topgt; lt;tdgt;8lt;/tdgt; lt;tdgt;-LRB-$454)lt;/tdgt; lt;tdgt;-0.58Rlt;/tdgt; lt;/trgt; lt;/tbodygt; lt;/tablegt;

When you have a complete R-multiple distribution for your trading platform, there are a lot of things you can do with it. But we'll save that for next week's topic.

https://forexintuitive.com/forex-tra...a-trading.html

Van K. Tharp, Ph.D..
http://www.tradingeduion.com/default.asp?Code=TE_ACF