A Controversial Forex Lesson on Forex Money Management & Measuring Your Trading Performance
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Today’s article is very important; it is a very different article from anything I’ve written and anything you’ve probably read. Due to the controversial nature of the concepts discussed in today’s lesson, I need you to hang with me until the very end…
Before we get into today’s article, let’s discuss the angle. This article is meant for shorter-term term traders who generally only take 1-3 positions at a time. Thus, it does not apply to diversified stock portfolios or hedge funds with many different assets under management for very long periods of time.
Not everyone will agree with the concepts I discuss in this article, but this is how I track trading performance and how many other successful retail and prop traders track their performance. This is what I do and it’s what I suggest…
Most forums and blogs discuss percentage and pip returns on traders’ accounts. However, in reality, measuring returns in percentages or pips is not the most effective way to track your trading performance. Every trader is different, and every trader brings with them a different set of mental variables and funds to trade with. Since this is the case, you should track your performance in terms of dollars risked vs. dollars gained (risk reward), which can ultimately be reflected in the number “R”, instead of percentages or pips. Now, let’s discuss WHY measure trading performance in terms of dollars risked vs. dollars gained, or R, is the best way to track your returns in the Forex market.
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– What is “R”?
“R”, as I define it, is a value that reflects the profit factor of a fixed risk Forex money management
strategy. Now, for those of you who don’t know what “profit factor” is, it is simply a value that reflects the profit of winning trades divided by the losses from losing trades. For example, if you gained $100,000 in one year of trading, but lost $50,000, your profit factor or “R” would be 2 or simply “2R”. (100,000 / 50,000 =2)
Thus, R is a measure of your overall risk to reward across all your trades, by knowing what our R value is for a series of trades we get a very quick and relevant view of our effectiveness as a trader. Think of it like this, if you have a 2R track record over a large series of trades, you can expect to make $2.00 for every $1.00 you lose in the market, a 3R track record would mean you can expect to make $3.00 for every $1.00 lost, etc. This is clearly the most useful and relevant way to track your progress as a trader, anyone who is considering funding you will want to see a long track record that shows a solid R value; the higher the R value the better.
– Percent risk vs. fixed dollar risk
The percent risk model deserves some special attention since it is probably the most popular risk-management model out there. I won’t go into a long drawn-out analysis of this because I have already written an article that you can read on this Forex trading money management topic. However, I would like to briefly explain why the percent risk model is not the way I manage my trading account…
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