Chapter 34 · Risk Management
R-multiples, expectancy and drawdown
Measuring results in units of risk, and the one formula that says whether an approach makes money at all.
Every figure below is worked in rupees on a portfolio of a size a Nepali investor would recognise. The arithmetic is not market-specific, but the reason it matters on NEPSE is: with circuit limits and compulsory delivery you cannot exit a losing position on demand, so the size of the loss has to be decided before you enter.
Why losses are not symmetric
Rupee profits and losses cannot be compared across positions of different sizes. Expressing every result as a multiple of what you risked makes them comparable — and makes it possible to say whether an approach works.
R-multiples
R is the amount you risked on a trade. If you entered at Rs 500 with a stop at Rs 460, R = Rs 40 per share. Every outcome is then measured in R.
| Exit | Result per share | In R |
|---|---|---|
| Stopped at 460 | −Rs 40 | −1.0R |
| Sold at 540 | +Rs 40 | +1.0R |
| Sold at 620 | +Rs 120 | +3.0R |
| Sold at 480 | −Rs 20 | −0.5R |
Now a Rs 40 gain on a small position and a Rs 400 gain on a large one are directly comparable, because both are stated relative to what was at stake.
Expectancy — the formula that decides everything
Expectancy = (Win rate × Average win in R) − (Loss rate × Average loss in R)
Worked, over 50 trades: 20 wins averaging +2.4R, 30 losses averaging −0.9R.
- Win rate = 20 ÷ 50 = 40%. Loss rate = 60%.
- Expectancy = (0.40 × 2.4) − (0.60 × 0.9) = 0.96 − 0.54 = +0.42R per trade.
- Risking 1% of a Rs 10,00,000 portfolio, that is Rs 4,200 expected per trade, before costs.
- A 40% win rate is profitable here. Being right less than half the time is not the problem people assume it is — the size of the average win relative to the average loss is what decides it.
Drawdown, and why it compounds against you
| Peak-to-trough loss | Gain needed to recover |
|---|---|
| 10% | 11.1% |
| 20% | 25.0% |
| 33% | 49.3% |
| 50% | 100.0% |
| 75% | 300.0% |
The formula is recovery = loss ÷ (1 − loss). The asymmetry is the entire argument for capping the size of any single loss.
Worked: a run of losses at two risk levels
Six consecutive losses, which any 40%-win-rate approach will produce eventually.
- Risking 1%: 0.99^6 = 0.941 — down 5.9%, needing 6.3% to recover. Uncomfortable.
- Risking 5%: 0.95^6 = 0.735 — down 26.5%, needing 36.1% to recover. Most people stop trading here.
- The approach was identical. Only the position size differed, and it decided whether the run was survivable.
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