christianh wrote:AFJ Garner, I agree with you, but still the original question is the validity of a change to to the R-multiple calculation because of its shortcoming. I like the concept of R and have built trading models around it but...

"Wouldn't it be better to change the R-multiple calculation to take not only the initial risk but also the ongoing open risk (whichever is higher) into its calculation?" So the new formula would be:

R = Return / Max(Initial Risk, Max Open Risk in Trade)

IMO, this new formula is "better" than the original one. I would like to hear others comment on it (flaws in the formula,...).

Christian

Christian,

I'm the one who created the R-multiple as a concept many years back. At the time all trading software (such as Trading Recipes) referred to expectation in dollar terms which I found next to worthless. A friend mentioned how the Turtles used volatility at trade entry to measure the progress of a trade and referred to them as "multiples of N" (where N was something like the 10 or 20 day ATR). I jumped onto looking at how trades in my systems looked in terms of their initially defined risk (since my main system used a volatility measure at entry).

I programmed Trading Recipes to spit out into a column the multiple of R throughout a trade along with the closed R. Since all trades were sized as a percentage of the portfolio equity (realize this was almost unheard of stuff in 1993-94 timeframe), I now had a method of equating the returns of a given trade that was independent of the specific market. Prior to that, stuff like Tradestation looked at only "dollars profit" based on the contract size of a specific market, etc (and still do by the way, 15+ years after Tom Basso tried to get Bill Cruz to create a "real" piece of trading software).

So the R-multiple was created to essentially normalize any given market to the whole basket of markets being analyzed. It didn't matter if it was a corn contract with a $15,000 face value or the S&P with a $200,000 face value -- they all spit out the same relative data, in terms of R. Again, it was important to reference to the initial risk, R, since that was what was being used to size the trades in relation to the account equity.

Once I reached that step, I then saw how I could now see deep into "how" a given system generated the equity curve outcome seen only as a continuous, bar-by-bar, curve. It then allowed expectation to be based on R instead of the worthless "dollar" measure. It showed how much return, based on the initial risk in a trade, a given system made along with how much "total open R" the system exit strategy captured. All my initial research looked at total open R on a bar-by-bar basis versus closed R in the trade. I developed many additional measures, distributions, etc, some of which c.f. has used in his software, to look into that â€œhow.â€