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Some good info I found along the way...
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%
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 .
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