For most traders, profit is naturally at the top of the priority list. Understandable, because that is why we do it in the end. But in doing so, they neglect the fact that profit can also be increased if we lose less. This means that a functioning and implemented risk management is the key to more profit in trading. But this is precisely what distinguishes the unsuccessful traders from the successful traders.
The key to risk management
As already indicated, the key to sustained success in the stock market is risk management that works for you. The R-method has established itself among successful traders for this purpose. However, what is the R-method, and how do you apply it?
The R simply stands for risk, and a 1R in turn stands for a risk unit. The value of a risk unit is completely individual and can change depending on the situation. From a practical point of view, the R reflects the maximum daily loss you are willing to accept. But what does that mean in concrete terms?
Let's assume that you want to lose a maximum of $500 per day. You can now determine for yourself that 1R = $500. Conversely, this also means that you can lose your entire daily risk with only one wrong trade, and thus your trading day could be over quickly under certain circumstances if your first trade was wrong. It would be better to define that 1R for you is $100 and your daily risk is 5R.
Why the R method is a game changer
Now that you know how to calculate your daily risk as R and how to apply it, what is the concrete advantage of this method? Quite simply, by using a variable to express your risk, you focus much more on the actual risk-reward ratio (CRV) and are not subconsciously driven by money!
The primary goal of trading is to make money. In doing so, we have the simplistic opinion that a profit – however high it may be – is positive and a loss of any amount is bad. But this gets us into trouble because even if we have made a profit on a trade, it does not necessarily mean that it was good. But if we focus completely on the R as a factor and not on the money as such, we become much more sensitive to whether the trading is perfect or not. Let's say you want to risk $1 in a trade and your target is $1.2 (going long) or $0.8 (going short). This means that this only gives 0.2R. This scenario would not be a good trade! Because it means that you could gain a maximum of 0.2R, but lose 1R. Your risk-reward ratio in this case is far too bad!
You realize that you can't make a good trade.
You will notice that this way of looking at things gives you a much clearer picture, and you will no longer be influenced and guided by money considerations. As a rule of thumb, we give our students that a trade must have at least a risk-reward ratio of 1.5R! Better even 2R or 3R. Anything less than 1.5R is not a good trade and should be avoided!
The R-method takes the mental pressure out of trading. Even if you are in the red, the term „-1R“ has a very different effect on you than the term „-$100“. This is primarily due to an area of the human brain, the amygdala, which always switches on prematurely when money matters. It becomes very active when there is a potential loss of money. It then becomes so active that it triggers panic and thus drives us to make wrong and rash decisions.
We can't be sure that we'll be able to make the right decisions.
So, thanks to the R-method, we can bypass this panic-mongering of our brain and thus make better decisions and at the same time make our trading more profitable. That's why successful traders are so profitable and why you should be doing the same, starting today.