The Risk/Reward R Calculation
Someone recently purchased Risk/Reward (thank you!) and had a concern about the cost of trade in relation to gains. With his permission, this is the email be sent me:
I just downloaded the app and noticed that “cost of trade” ( assume to
be commission expence) works correctly for loss on sales where stock
price goes down, however it appears to be additive on gains (profit)
when stock price goes up. I would have expected the cost of trade to
always reduce the return; increase losses and reduce gains. Will this
calculation be revised in future app release?
So, let’s take a look at what a calculation looks like. With an upcoming version of Risk/Reward you will be able to email yourself the results, so let’s use that feature for this. We’ll take a simple position so that the math is easy to see:
Risk/Reward Results (2009-9-27 10:44 AM)
Trading Parameters
Share Price: 10.00
Max Loss/Share: $1.00
Number of Shares: 100
Cost To Trade: $10.00
Type of Trade: Long
Risk (1R)
R Sell Price Loss
1R 9.00 110.00
Reward (nR)
R Sell Price Profit
1R 11.10 110.00
2R 12.20 220.00
3R 13.30 330.00
4R 14.40 440.00
5R 15.50 550.00
6R 16.60 660.00
7R 17.70 770.00
8R 18.80 880.00
9R 19.90 990.00
10R 21.00 1100.00
In the trade above, the cost of the trade was $110.00, so this is the 1R. Cost of trade, or, as Van K. Tharp calls “The cost-of-trading opportunity”, includes commissions (to buy and sell), execution costs (slippage, i.e., you never get the exact price you want), taxes, and psychological costs. So, altogether, for this trade, you are risking $110.00 (1R). In order to realize a profit of 1R (again, $110.00), you would have to exit at $11.10. To gain 2R, or $220.00, you would have to exit at $12.20, and so on. The R-value is a multiple (i.e., straight multiplication) of the risk.
If this calculation does not match up with your take on the R-multiple risk for a trade, please let me know, either by commenting below, or sending me an email: lucasrockwell at lucasrockwell.com.
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