Performance & Risk

A question we get very often is "What have your percentage returns been?"

On the surface, this seems to be a pretty easy question to answer. And it is - but not perhaps in the way most would expect. We usually answer - "Well, that depends on what risk you were willing to take".

Each member's percentage return will depend on their Position Size - being the Risk each member took for each trade.

The position size ('how many' shares you buy) is determined by the amount of risk you are prepared to take on a trade. It is this factor that dictates the magnitude of the return, with all other parameters being equal (as they are in this case).

So how do we create a common measure for our Performance - one that provides the truth, no matter the risk profile of the trader? The answer is by measuring it with a constant - measuring it with a "Risk Multiple", the "R-Multiple" as we call it.

When we are trading on a short term basis, we define Risk as the difference between our Entry Price and our Initial Stop Loss. This allows us to express the risk of the trade on a 'per share', 'per ounce' or 'per contract' basis. This is the first step to creating a common measure of our performance.

Here is an extract of a live recommendation we sent out:

We have identified a SELL ('short') position in Gold.
SELL "Gold - Dec 12" @ 1,748 On Stop (not 'at market'). Stop Loss @ 1,758 (10 points risk). Risk per contract is A$1,000.

You can see the difference between the entry price (1,748) and the Stop Loss (1,758) was 10 points - or $1,000 risk per contact. We therefore define the risk of this trade to be "$1,000 per 1 contract".

Now, let's look at how the Position Size is affected by the risk profile of each member, and then how this affects the usual "performance" measure of the trade.

Member A is trading with $10,000 in their account. They are prepared to risk 10% of their capital on each trade - being $1,000.
Therefore, their position size is 1 Contract.

Member B is trading with $100,000 in their account. They are prepared to risk 5% of their capital on each trade - being $5,000.
Therefore, their position size is 5 Contracts.

The result of this particular trade was that we closed the position out at 1,715 - for a gain of 33 points per contact.

So each trader made exactly the same trade, with the same entry and exit points, and here are there "results":

Member A profited $3,300 from the trade; being 33% return on capital.
($3,300 profit/10,000 capital x 100 = 33%)

Member B profited $16,500 from the trade; being 16.5% return on capital.
($16,500 profit/100,000 capital x 100 = 16.5%)

Their "Performance" was affected ONLY by their Risk level, which determined their Position Size.

Let’s look at that trade again - a real 33% return in less than 10 days, on a single trade.

If we use the ‘traditional’ approach to determine the performance we made $33 on $1,748, being 1.89%. A return not really reflective of the true performance of the trade!

What gives us the best measure of performance when trading short term is our “R-Multiple” - or “Risk Multiple”. This Risk Multiple tells us how much we gained or lost, based on a multiple of what we initially risked. This measure allows us to uniformly measure our performance across trades. It also gives you the opportunity to test and trial how different risk levels would have performed.

So to complete the example above, a $33 profit on the trade was really a multiple of 3.3 times the initial risk of $10; so the Return could best be described as “3.3 R”.

Member A can look at this result of 3.3R and say, “Yes, I risk 10% per trade, 10 x 3.3 = 33% return, and that is what I returned”.

Member B can look at this result of 3.3R and say, “Yes, I risk 5% per trade, 5 x 3.3 = 16.5% return, and that is what I returned”.

R-Multiple Formula:

R-Multiple = Profit (or Loss) / Initial Trade Risk

Initial Trade Risk = Difference between the Entry Price and the Stop Loss.

 

With the “R-Multiple” we now have a way of standardising our performance.

Your membership allows you to control your own money, and your own level of risk - giving you control of your own degree of returns as well.

NOTE: This is not an endorsement or recommendation to risk 10%, or even 5% of your capital each trade - but instead it is for a simple comparison. You should determine your own risk profile; and remember doubling your risk also will double the extent of any draw-down (losses) you will need to endure. Past performance is no guarantee of future performance.


Using the R-Multiple of Compare Trades

The “R-Multiple” (Risk Multiple) method also allows us to make all our trades ‘equal’.

Again, a point best made with a real example. Here is an extract from a Silver trade recommendation we issued:

We have identified a Sell opportunity on Silver.  

BUY "Proshares UltraShort Silver" at $40.19 on Stop (not 'at market'). Stop Loss @ $36.69 (risk of $3.50 per share).

Risk of $1,050 for every 300 shares.  

The final result of this trade was that we sold our position at $45.82 - being a profit of $5.63 per share, or 14% return (in 20 days).

The 14% return here would suggest it was a much ‘better’ performing trade than the Gold trade above, which made a tiny 1.89% by comparison.


But was the Silver trade really a better trade?
Let’s apply our “R-Multiple” to the example:

Our Entry Price was $40.19, our Stop Loss was $36.69; giving us a risk of $3.50 per share.

Our final profit was $5.63 per share ($45.82 sale price, less $40.19 purchase price).

This profit was therefore “1.61 R”.

That is, we returned 1.61 times our initial risk - less than half of what the Gold trade returned us… when we look through this risk adjusted lens.

So now we have a way of representing our Performance so that each member, and new members, can see how that would apply to their risk profile; and we also have a way to compare the risk adjusted performance of each trade.

Each time we are taking a trade, we are taking on risk. Each trade we want to standardise that Risk. Our performance, and in fact the performance of each trade, can then be represented as a Multiple of R, the “R-Multiple”.