$$ Relationship Between Position Sizing, R-Multiples and Trade Win %

For the swing/day trader, all three concepts are interrelated. The common denominator is how far away you place your initial stop loss.

Assume you risk 1% of account per trade. Assume account value is $100K. If you enter at $30 with a $29.70 stop loss and a $32 target, your risk is $1000, your position size will be (1000/.3) = 3333 shares * $30 = $100K or 100% of your account value in the trade.

If you hit your target at $32, you make $2/share or $6666. Your R-Multiple is 6.67R.

Of course, your stop at $29.70 is fairly tight, and you will be stopped out more often than with a looser stop, say $29 even. The tighter your stop, the greater the negative impact on your trade win percentage and vice versa.

If you made the same trade with a $29 stop, risking $1 a share, your position size would be 1000/1 = 1000 shares *$30 = $30K or 30% of your account value.

If you hit your target at $32, you make $2/share or $2000. Your R-Multiple is 2.0R.

To compensate for the lower R-Multiple, you will hit your target more often than you would with a $29.70 stop loss.

Bottom line, for the short term trader there is an art to placing your initial stop loss which directly affects how many shares you buy per unit of risk, what your R-Multiple reward will be compared to your risk, and how often your trade will be successful.

In a future post, I'll discuss how to compare the mathematical expectancy of the two trades outlined above.