DAYTRADING/SWINGTRADING STOCKS with INTRADAY INVESTMENTS Message Board

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Strategies & Market Trends : DAYTRADING/SWINGTRADING STOCKS with INTRADAY INVESTMENTS

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To: - who started this subject	5/30/2001 12:17:15 AM
From: deronw	of 565

Making certain your risk/reward ratio is favorable: In the current sideways market conditions we have been experiencing, one way to improve your odds of having a profitable trading day is to always make sure that your risk/reward ratio is positive before entering any trade. The risk/reward ratio is simply a quantitative measure of the potential risk for loss in any given trade versus the potential amount of profits to be made in that same trade (the reward). The ratio of both the risk of loss and the ability to earn profits is called the risk/reward ratio. In order to put the odds mathematically in our favor, we tend to avoid entering trades in which the risk/reward ratio on any given trade is not at least 1:2. This means that we are looking for the potential profit on a particular trade to be at least double the potential loss (stop loss). Let's look at a hypothetical example to illustrate this point. . . Suppose you are considering entering a long position of JNJ at a price of $75. Upon careful technical analysis, you realize that the ideal place to set a stop loss would be just below the stock's most recent support level of $74. This would potentially give you a loss of $1 per share if you were to get stopped out of the trade. So, if the "risk" is $1, then you would want the potential profit (your target) on the trade to be at least $2. Therefore, if your technical goal was not for JNJ to trade up to AT LEAST $77, then you are better off to pass the trade by because the risk/reward ratio would not be at least 1:2. Another example would be the case of a high-beta stock (let's say NVDA) that has already dropped by 15% on the day, and you are considering shorting it at the lows of the day, after a 15% intraday drop, which took the stock to its maximum average daily range. Even without knowing where our stops and profit targets would be, you can probably answer the following question pretty easily. . .Is this a good risk/reward ratio? No, it's not a good risk/reward because you are risking the stock easily going several points against you to the upside for the possible reward of the stock possibly dropping another 1/4 or 1/2 point. Even if the trade would end up being profitable, we would NOT enter the trade simply because the risk/reward ratio is out of line. This is why we typically wait for bounces before selling short and pullbacks before buying intraday. Although there are numerous factors that go into setting stop losses and profit targets, this formula is a great supplement to always use when you are unsure if a trade is a worthy risk. Use this formula when entering all trades and it will keep you out of major trouble (assuming you have at least some basic knowledge of setting stops and profit targets). Trade Well! Deron

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