Advanced Risk Multiple Tracking can uncover some powerful ways to improve your trading strategies. This guide will show you how to do this simple analysis and the hidden issues that it can help you identify in your trading.
If you are already familiar with the concept of Risk multiples, skip down to the next section. I've found this analysis super useful, so I would encourage you to do it too. The best part is that you might only need to do this once to get the benefits.
Alright, let's dive into it…
Table Of Contents
What is a Risk Multiple?
If you are not familiar with the term risk multiple, it was popularized by Van Tharp, as a way to measure the outcome of a trade, based on the amount risked.
Of course, this assumes that you use a stop loss, which you should always use when you take a directional trade.
The amount you risk on a trade is always 1R.
So if you risk 100 pips on an EURUSD trade, 100 pips is your 1R for this trade. If you risk 54 pips on the next trade, that's 1R for that trade. The Position tool in TradingView makes it super easy to measure Risk multiples on your charts.
If you have a profit target at 200 pips with 100 pips of risk, then your potential reward on the trade is 2R.
Traders also call this the Risk/Reward Ratio.
(Yeah, it's technically a Reward/Risk Ratio)
A risk multiple makes it really easy to see your performance, relative to your risk. Percentage return or net pips can be very misleading because they hide the amount of risk that you are taking to get your results.
Your risk multiple has an inverse relationship to your win rate.
If the win rate of your trading strategy is high, you will probably have a low risk multiple. If your win rate is low, then you will need to have a high average risk multiple per trade to make money.
Of course, a high win rate and a high average multiple is ideal, but it doesn't work that way. There are always trade-offs in trading and you need to find the best balance for your trading method.
Many traders track the risk multiple of their wins and losses.
That is fantastic and doing this will give you much more insight than just tracking your win rate.
But we can do better…
What is Advanced Risk Multiple Tracking?
Tracking the maximum risk multiples of your trades can give you even more clues as to how you can optimize your trading.
This is Advanced Risk Multiple Tracking.
If you start tracking the following advanced R-metrics, elements of your trading that you can improve on often become crystal clear. The best part is that now you also have an objective way to measure your improvement in these areas.
It's not necessary to track all of these metrics, so figure out which ones will help you and throw out the rest. Look for trends over time because something that only happens once could just be a fluke.
Also remember to apply these metrics at the trading strategy level.
Each trading strategy will require different optimizations.
Alright, here are the advanced R-metrics that you can track to start optimizing your trading…
Risk Multiple Tracking for Winning Trades
The obvious R-metric to track here is the average risk multiple of your winning trades.
But that has limited use.
So let's step it up a level…
Maximum R During Trade
Tracking your maximum risk multiple during each winning trade can show you if you are chickening out and closing trades too early, or if you are closing out too late and need to set a hard profit target.
This is also known as Maximum Favorable Excursion or MFE.
To measure this, track the highest risk multiple that each trade could have made, before you closed it. Then calculate the average over 30 trades or more.
If this number is greater than the average risk multiple result of these trades, then figure out why this is happening.
It could just be a natural function of your strategy. This can often happen with trend trading strategies.
But it might also be an opportunity to optimize…
For example, let's say that you have 80 winning trades with an average of 1.4R profit per trade. But when you go back and do a “maximum R before close” analysis, you find that these trades have an average potential of 2.6R.
Now you can ask yourself some key questions:
- Am I closing these trades before they hit the profit target?
- Should I be setting a 2R profit target instead of exiting manually?
- Can I use multiple positions to try to capture this extra profit?
Then you can start to experiment with your strategy in backtesting and/or forward testing to see what effect these changes might have.
Maximum R After Trade Closed
I believe in doing a follow-up review of all my trades, a week or more after they close. This allows me to review them more objectively because my emotional attachment to them has dissipated.
A follow-up review also allows me to see how much more money I could have made on each trade.
Duh, nobody can get the maximum R out of every trade.
But if my average potential R per trade is much higher than my actual R return per trade, then I am leaving money on the table.
If I know this, I can review my trading strategy and figure out if there is a way that I can extend my profit targets or use multiple profit targets.
It might not be possible to do so and still remain profitable. But if you know this, you can at least explore ways to improve your return per trade.
Risk Multiple Tracking for Losing Trades
OK, let's start with the elephant in the room…
If your average risk multiple for losing trades is greater than 1R, then you have a huge problem. You are moving your stops and that needs to…stop.
But if you notice that your losing trades could capture 1R or more before hitting the stop loss, then you might want to look at your exit strategy. You may be setting your profit targets too far away or you could benefit from using multiple positions.
Again, test these ideas and see if they improve your results.
Risk Multiple Tracking for Breakeven Trades
Tracking the maximum risk multiple on your breakeven trades can show you if you are exiting at breakeven too quickly.
To get this metric, track how much of that sweet R you could have made if you didn't move your stop to breakeven or if you didn't manually exit at breakeven. If this average is consistently higher than 1R, then you should probably look at your rules on moving your stop to breakeven or how you are manually exiting your trades.
Risk Multiple Tracking for Missed Trades
Finally, it helps to take a look at the potential R-return that you could have made or lost on your missed trades.
Yeah, yeah…I know what you are thinking…
There can be some hindsight bias when you look at missed trades.
But I would argue that hindsight bias only comes into play if you don't have a well-defined trading plan.
If you scroll your chart back to the entry point and it looks like a trade that fits your criteria, then you need to be honest with yourself and make the call on if you would have taken that trade or not.
Tracking the risk multiples of missed trades can help to build your confidence…or expose potential weaknesses.
If you lost -2R this week, but you had +5R in missed trades, then you are on the right track. You just have to figure out how to stop missing those trades. This can be a huge confidence booster, especially during a rough week.
On the other hand, if you had a +3R week, but you had -10R in missed trades, then you may have been lucky and dodged a few bullets. I certainly wouldn't stress it if this happens once in awhile.
But if this becomes a trend, then you need to examine why this is happening.
….or you could have a ticking time bomb on your hands.
How to Track Advanced Risk Multiple Metrics
I use Evernote as my trading journal because it's stupid simple and almost as flexible as a yoga instructor at a Twister party. Tracking custom metrics like advanced risk multiples is a breeze.
If you put this information in the titles of your journal entries, you can see your risk metrics at a glance. You can use tags to filter by trading strategy, win/loss, currency pair and any other category you want to create.
Of course, to get exact averages, you would have to use a spreadsheet. But sometimes eyeballing can be enough to understand where you can make improvements.
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Beware of trying to over-optimize. Some things simply cannot be optimized with this analysis.
However, advanced R-metrics are super easy to calculate and can be a quick-and-dirty way to figure out how you can improve your trading.
You are simply looking for clues that you will need to stress-test.
If you haven't done this analysis before, give it a try right now. You might be surprised at what you uncover.
What did you find out after doing an Advanced Risk Multiple analysis?
Share your experience and leave a comment below…