When it comes to making money in the markets, risk management is probably the most important factor to long term success. To learn how to make money, you must learn how to stop losing first. Risk is all about controlling your losses. They can’t be prevented, but they can be analyzed and limited.
Here are 4 risk based metrics that even novice traders can track via a simple spreadsheet or a trading journal.
1. Stops and targets
If you don’t know where you stop is before entering a trade, you should not be in it. Likewise, profit targets are just as important. If you don’t take profits, you could waste your profits. Knowing these two values before entering a trade is essential.
2. Risk per trade and portfolio risk
With your stops, you can calculate the amount of money you are risking per trade. It’s also important to know your portfolio risk, meaning how much you may lose if all stops are taken. This will help you know how your portfolio is balanced and whether it’s adjusted for risk.
Let’s look at an example:
If you buy 100 shares of AAPL at $100 with a stop loss at $90, you are risking $1000 on this trade.
Do this for all your positions and sum up the values to calculate your total portfolio risk also known as total risk exposure.
3. Profit factor
If you are risking $1 to make $3, that’s a great profit factor of 3. If you are risking $1 to make $1, that’s a profit factor of 1 meaning you are breaking even. Over time, it’s not about winning on a trade, it’s about letting the profits run while limiting your losses that will help you increase your profits. To calculate your profit factor, sum up the profits of your winning trades and divide by the sum of your losing trades. Shoot for at least a ratio of two. Less than that and you are wasting your energy.
R-multiples is just another way of looking at risk. In other words, you are no longer looking at how much (in financial terms) you making or losing, but how much R’s:
Here is an example:
If you buy 100 shares of AAPL at $100 and your stop is at $95, every R equals $5 and therefore that’s your R-multiple. If you sell it at $120, your r-multiple for this trade is 4r which is a great multiple. If you sell it for $95, your R multiple for this trade is -1R. Notice that the amount in $ is abstracted from your risk equation and all you need to know now is how many R’s you are risking.
All trading-related metrics can give you some sort of direction about where your trading is going. Monitoring your trading metrics is like monitoring your blood tests. A blood test will show you that you are eating bad food the same way your risk metrics will show you that you are holding on to losers.
Trademetria is a complete trading journal that not only brings these 4 risk metrics explained in this article but many more.