|
PureBytes Links
Trading Reference Links
|
** Risk (vs) Reward Ratio Formula ** ____________________________________________________________________________ I have received a few questions regarding Risk (vs) Reward Ratio Formulas. I have used this Ratio in a few examples in the past. Although Risk is something you have to judge for your self in as far as your trading style . There are a few generally accepted ratio formulas. This is hard to explain since it is part of a total money management system, however if you allow me to give you some basic back ground on portfolio management it will make more
sense. The first thing about money management you must understand is DEFENSE is extremely important. For example a 25% loss would require a 34% gain just to break even not counting trading cost. A 50% loss would require a 100% gain just to break even again not counting trading cost. A 80% loss would require a 400% gain just to break even, Ex: $100 - 80 = 20 x 4 = 80 or expressed another 400% !!!!!!!!!!!!!! Take for example the Baltimore Ravens XXXV Super Bowl Champions. The Ravens are an excellent example they won the Super Bowl with DEFENSE. By the way the Ravens are my home Team. I will begin with the simplest Risk (vs) Reward Ratio Formula. / Risk (vs) Reward Ratio Formula. In order to calculate risk you must look at Technical Analysis, & understand stock pivot points, support & resistance levels as well as market momentum. The next step is to establish a trading journal,& then a list of potential of either
buy or sell candidates. I call this my watch list, I further divide it into categories Buy List, Sell List, Put or Short List, Call or margin Buy List. So we now find a stock that we believe is a good buy candidate { XYZ } & we look at its sector & see that it is either in favor or should soon rotate into favor. Next we look for a catalyst to move the stock, Earnings Report, New contract awarded etc... We then look at technicals such as Bollinger Bands, Money Flow ={ MFI }, ADX, MACD, RSI. We now look at 52 week high, 52 week low, 5 day moving average, 20 day moving average, 50 day moving average, 100 day, 200 day moving averages. We ideally want { XYZ } at or near its 52 week low, with its 5 day moving average above its 20 day moving average. We want to establish a Maximum loss on the trade that we are willing to accept. We can either use a straight % such as 10% loss or use a support level below our
entry level as an exit price or even a % below the stocks support Level such as 5% . Thats say we have decided to take 3% from our risk portfolio, 3% is mathematically the maximum amount you can risk of your total capital in blackjack in order to stay in the game. I personally go a bit further & Divide my capital into 2 separate portfolios. one is passive & one is actively managed. I Typically put 70% in the passive portfolio which is a combination of the S&P-500 & Short Term Treasuries. & 30% in the active portfolio, this is the one that is actively traded. I further take 10% of the active portfolio, which is 3% of the total portfolio & allocate it for penny stocks. Thats say your total capital for investing is $ 100,000.00 , you would allocate $ 70,000.00 to your passive portfolio & $ 30,000.00 to your Active portfolio. out of the $ 30,000.00 you take $ 3,000.00 for hyper aggressive pennies. Now back to our { XYZ
} stock, it has a price of $ 20.00 & a 52 week high of $ 60.00 & a 52 week low of $ 15.00, The Stock has a support at $ 20.00 & resistance at $ 27.00. We set a target price of say $ 30.00 based on fundamental & technical analysis + economic climate & what we believe will be an up turn for the company in the next few months based on a possible increase of demand for { XYZ } product. Now for the basic formula our entry price is $ 20.00, Stop loss at $ 15.00, which is the next support level we then enter our target price of $ 30.00. So our max loss is $ 5.00 per share not counting trading cost. Our max gain is $ 30.00. So 100 shares at $ 20.00 is $ 2,000.00, if we had to to sell it at $ 15.00 a share, we would loose $ 5.00 a share or $ 500.00. If the stock goes to $ 30.00 a share, we would sell it & have a profit of $ 10.00 a share or $ 1,000 . So here we are looking at a 2 to 1 ratio. Potential loss is $ 500.00 which is half of $
1,000.00 . There are other more complex formulas, such as comparing it to risk free investments such as Treasuries, & also comparing it to its own bond yield (vs) stocks earning yield. There are various approaches to investment management. I will have more on this later in a follow up Article: Engineered Portfolio Construction . Link http://www.groups.yahoo.com/group/AAQuants/join Please Forward this link to a friend. ~ Bill ~
Do you Yahoo!?Win a $20,000 Career Makeover at Yahoo! HotJobs
Yahoo! Groups Sponsor
ADVERTISEMENT
Yahoo! Groups Links
To visit your group on the web, go to:http://groups.yahoo.com/group/equismetastock/
To unsubscribe from this group, send an email to:equismetastock-unsubscribe@xxxxxxxxxxxxxxx
Your use of Yahoo! Groups is subject to the Yahoo! Terms of Service.
|