A Simple Ratio For Spread Betting
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An important part of financial spread betting is managing the inevitable individual trading losses that will occur. Money management discipline has been pounded home in every trading book and seminar by every guru or market wizard. The mantra goes: manage your losses and the wins will take care of themselves.
But we don’t learn at the most cellular level from books or seminars. We learn from real world experience. All the trading books in the world will not mean a thing until we have felt the pain of losing valuable trading capital. Only when it hurts can we truly appreciate what good money management is all about.
From my own experience, when I have been knee deep in losing positions the last thing I am capable of is making rational decisions based on book knowledge. Individual trading losses play havoc with the emotions of traders and all too often speculators lose their focus.
Spread betting uses leverage and leverage creates tensions. If we are winning we think we are a market genius while if we are losing we tend to get upset, angry or even depressed. Such is the nature of trading. Rare is the person who can stay emotionally balanced in the face of either mounting losses or winnings.
What we need is something that will tie us to the mast so that we can weather those emotional ups and downs with objectivity. We need to plan ahead so that when we are about to experience a losing trade we already have a strategy in place to deal with it.
The first line of defence is the much talked about and celebrated protective stop loss order. No trader should begin trading without them.
However I know I am not the only trader in the world who has violated my own stop loss discipline the moment my trade started gunning for that magic number.
I am only human and losses hurt like hell. We are programmed by society to not be losers. Losing is bad. Losing money is really bad. It is therefore no surprise the lengths we go to in order to avoid them.
Stop losses are a good tool in a traders arsenal but I personally need more. I need to examine in black and white what an idiot (or market genius) I have been after the event.
Enter the R-Multiple. What is it? My explanation is best served with an example.
Suppose I have entered a trade and I have allowed myself a permissible loss of £50 on that trade.
That is my 1R.
If I close the position out with a profit of £100 then my R-Multiple is 2R. I have doubled my return on capital.
If I close the position out with a profit of £150 then my R-Multiple is 3R. I have made three times the capital I was willing to lose.
And if I have a loss of £100 then I have a negative R-Multiple of 2R.
In the last example only one of two things can have happened a) I disobeyed my stop loss discipline or b) the market gapped seriously lower and the first price I could get before my stop loss order kicked in was £100 below my entry point. This is uncommon and though it does happen in all likelihood would rarely result in such a poor R-Multiple.
Some people use nominal amounts in analysing their trading results and that’s fine with them but it does not give a true reflection of how well a trade went.
Every savvy investor knows its return on capital that counts and not the capital amount itself. The R-Multiple is merely a measurement of return on capital employed.
Monitoring my R-Multiple has given me an awareness of my trading ability and performance that I never had as a novice. It is a vital money management tool that I believe has saved me from the blow up graveyard, and as such cannot be ignored by financial spread betters.
More articles about R-Multiples are to be found at http://www.iitm.com/sm-risk-and-r-multiples.htm or http://tradermike.net/2006/09/r_r-multiples_defined/
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Tags: Blow up, Leverage, Money Management, Online Spreadbetting, R-Multiple, Risk, Simplicity, Trading System
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