The Chinese word Tao can be translated to mean way or path, and when it comes to trading the concept of R represents risk units, which is defined as the dollar amount a trader is willing lose on a trade if the trade drops to a predetermined stop. Thus, the Tao of R is a road to changing our mindsets from focusing on dollars lost or gain during a trade to focusing on continuously being a successful trader. However, the philosophy of the R goes much deeper than just limited our losses on a trade.
By its nature, the principle of R is designed to remove as much human emotion as possible from the trading process. When you set your R value to a dollar amount, say in this case you set it to 100 dollars, then you know exactly how much money you could potentially lose on your next trade. There is no guesswork involved. You set your trade, you set your stop, and you let the trade play out. If the trade turns against you, your main capital pool is protected by using a stop based off your R value. If 100 dollars is too much of a loss than you set it for less. Whatever dollar amount you are comfortable with is your current R value; however, we do recommend setting your R value to a maximum of 2% of your trading account. So, if you have 2,500 dollars in your trading account, your R value should be set to 50 dollars, which means 50 dollars is the most you will lose during any given trade.
However, knowing the path is very different from traveling the path, and when it comes to using the path of R in your active trading it can be implemented with the following steps. Some of these points we have already touched on, but let’s list them all in order from start to finish. First, we need to determine the R value, which we will use consistently over a set period of time or a set number of trades. Secondly, we need to determine the entry price of our trade and the stop price of our trade. Thirdly, we need to calculate how many shares we will purchase by dividing our R unit by our stop number. Fourthly, we identify our target number by our chart and calculate the R. Finally, if the risk to reward is around 3 to 1, then we set up the trade and enter it when the conditions are met.
It is important to remember, once you have your R value set, we recommend staying with that value for set period or a set number of trades such as 30 days or 20 trades. Some of the main benefits when implementing the concept of R are: it removes the emotional attachment to money, it keeps your loses limited to a set amount, it helps you increase the size of your trades in a controlled manner over a set predetermined period of time, and finally, it keeps your eyes on trading consistently. Only when your R value is constant are you able to effectively analysis your trading results.
This overview of the R principle outlines the main points of implementing risk units or R in your day to day trading. When done so consistently and correctly, the risk unit system will remove a good portion of the risk associated with trading, the guesswork from our trading, and the emotional fears of a trade turning against us. The Tao of R is a path worth walking and a serious investment in improving our trading toolkit.