Trading Return on Risk Projection Tool

A link to view and download my Return on Risk Projection Tool Google Sheet can be found at the end of this post.

I talk on Twitter about the importance of defining 1R (your static risk on every trade) as part of your trading methodology. When you keep your risk static on every trade, you significantly decrease the chances of destroying your account via a drawdown or even a few disastrous trades.

All too often, traders are focused on their win rate. However, as the following table illustrates, win rate should always come second to Return on Risk.

In the table above, the following variables are set:

  • The Initial Account Balance is $100,000
  • The percent of the Initial Account Balance risked per trade is 1%
  • The dollar amount risked per trade (1R) is $1,000 ($100,000 x 1%)
  • The number of round trip trades per week is 20
  • The average commissions and fees per trade is $40
  • The average Win Return on Risk is 2 (in other words, the average win is 2x (2R) the size of the average loss (-1R)

When looking at the table, you’ll notice that, given all of the above variables, profitability is achieved with a win rate of just 35%, or roughly 1 out of 3 trades. This means that you could lose on 2 trades (-2R) and win on the third with a return of 2R and have a breakeven to very slightly negative P&L.

Let’s adjust the average Win Return on Risk to 3 and see how things change.

When adjusting the average Win Return on Risk to 3, breakeven is now achieved at a win rate of 26%. This means that breakeven can be achieved by losing on 3 trades (-3R) and winning on only 1 with a return of 3R. Pretty fucking awesome son.

When you hear other traders saying to let your winners run and cut your losers, this is exactly why. Risk management should always be your number one priority. If you size your positions based on a static amount of risk on every trade, then you are already tipping the scale of potential success in your direction in a very meaningful way. Once you understand this, you can then work to program your mind into understanding that trading is not about getting it right every time. Hell, you don’t even need to get it right half the time (and many highly successful traders don’t).  Just focus on honoring your stops at -1R (making sure that your stop location is at an actual invalidation point that other traders in the market are also basing their risk against as opposed to simply placing an arbitrary and contextually meaningless stop just to have one in place) and focus even more on letting your winners run to their original target. If you’re worried about getting stopped out or being wrong, then refer to this spreadsheet and remind yourself that this is how the real trading game is played – with many small losers, and fewer large winners.

Here is the link to my Return on Risk Projection Tool Google Sheet document as described in this post. Though the document itself is not editable, feel free to “Make a Copy” within Google Drive by going to File -> Make a Copy (you need a Google Drive account in order to be able to do this). As an alternative, you can download it as a spreadsheet file which can then be opened in your offline spreadsheet app of choice by going to File -> Download As and then selecting your desired file format for export. Plug your own numbers in to the right column fields in the blue box and experiment with different variables so that you can better understand this concept and how it compares to the current risk management and position sizing system of your methodology.


Questions or Comments?

If you have any questions or comments about this post, then feel free to send me a Mention or Direct Message on Twitter @BreakingOutBad.