Risk of Buying or Holding a security can be Calculated and Quantified on a scale of (1 to 10) very accurately if you have the Tools to perform just a few computations. Reward is a bit more difficult to Quantify, but when you first mitigate the Risk and use a few more basic Tools -- this job can be accomplished too!
If this opening paragraph is of interest to you and you are a "Serious Investor" I would like to share clear support on how you can enjoy consistent and very low Risk annual profits.
I have found that very few Investors and Financial Analysts take the time to "Mitigate Risk." For me, it is one of the first things I do in my analytics of each and every security.
Explaining the 'Risk / Reward Ratio'
Simple (textbook) Explanation: Let's say an Investor purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that the losses will not exceed $500. Let's also assume that this Investor believes that the price of XYZ will reach $30 in the next few months. In this case, the Investor is willing to Risk $5 per share to make an expected return of $10 per share after termination the position. Since the Investor stands to make double the amount at Risk, the Risk / Reward Ration is 2:1 on that particular security. Just for the record, I seldom recommend the use of stop-loss orders.
Unfortunate it is the simple and a much too basic Explanation that will get definitely get you into trouble.
Perhaps a More Realistic Explanation (that requires time - doing your homework well): The same Investor using the same XYZ security has "Raw and Accurate Data that "Confirms" the 2:1 Risk / Reward Ratio. You may note that -- I have removed the word "Believes" (from the first Explanation) and added the words "Accurate Data that Confirms" (to this Explanation). I hope you can see the enormous difference in these two "words" makes such a difference! Assumptions and "Beliefs" must be BASED on something very solid. And I suggest that - that "SOMETHING" is Raw and Accurate Data. Obviously, if - and I mean "IF" - my "Raw and Accurate Data" presents a 2:1 or in the above example a 50% Reward, I will jump on that Investment Opportunity every time. In my first sentence of this article I use the term "Quantified scale of (1 - 10)" for both Risk and Reward Calculations.
That simple means a) that I separate my Risk and then Reward calculations. b) that if I have a Negative or Risk of (1 - 10) I would not consider investing in that security. c) that if I have a Positive or Reward of (1 - 10) I would strongly consider investing in that security. d) that if I have a (3 or higher) Reward, which I require, I can very comfortable Buy that security with much confidence. e) the opposite is true if I have a (3 or Higher) Risk, which I require, I can very comfortable Short that security with much confidence. ( One of My Rules: Bearish investing require a very Pro-Active Investor for me to make specific Bearish Recommendations ).
For me, the task "Investing Wisely" is based on "My Methodology" -- that must first be understood, as well as possible from your study of the following URL: "My Methodology:" http://www.safehaven.com/article/27312/my-methodology
There is an axiom of the stock market called the three Ts. It infers the competing with the pros is foolish and often expensive. The three Ts are: Time / Temperament / Training. The profitable "pros" have these needed characteristics. Do you Really have and spend the time, have the psychological temperament and education in finance and economics - training?
Risk / Reward Ratios can be Calculated for: AA, AAPL, BAC, C, CMCSA, CSCO, F, GE, GOOG, INTC, MSFT, T, XOM or just about any security on the planet. (To view my 20-Year Charts of the above symbols - Click on the Symbol).
I invite you to "plug into" an Email Dialog with me for more details regarding Risk / Reward and My Methodology. I can assure you and even guarantee that the "Results" of your being just a bit "Pro-Active" about your investments the will be well worth your time.
Perhaps you have already seen the (Year to Year Profits) using my formula F + C = R in my on going articles here in SafeHaven.com.
This is often my introductory paragraph for this formula:
It is Really Quite Simple - F (plus) C (equals) R
It begins with Accurate "Forecasting" and Analytic Procedures that produce consistent profits, then it requires Well Honed Fundamental, Technical and Consensus Opinion - "Confirmations," and it nearly always ends with Profitable - "Results." (F + C = R)
The Risk / Reward Ratio is calculated early-on in the work / analytics I do in my Forecasting procedure. Obviously, this is of vital importance if my "Forecasts" are indeed going to be Accurate. Just for the record, my Forecasts are well above 95% Accurate and that is producing excellent Results!
You might remember what I also share in many of my articles for these Blogs. "You can roll the Dice or learn that by doing the necessary work / analytics you can begin to enjoy consistent annual profits and sleep very well at night."
I believe that this present-day Stock Market is Controlled and Manipulated by both the U.S. Government and by Wall Street. This is all done by a continuous flow of propaganda via the cooperative media. "Liars can Figure but Figures can't Lie!" My presentations via missives such as this one and my weekly articles have nothing to do with "story telling" / "hype" / "sales pitches" or "propaganda." They are ALL based on Hard / Raw Data and Figures and that is NO LIE ! I am here to help.
This is an excellent graphic that I often share regarding the Risk / Reward Tradeoff. Perhaps you will want to ponder the "Why" this (simple Red Line) is so important to Me and perhaps will be important to You?
Clearly, the term used in the x-axis at the bottom of this graphic may cause you to scratch your head, just a bit. The words "Standard Deviation" is something most all Financial Analysts work with mathematically quite frequently. It does what I said above, if performed correctly, it gives a Ratio that is either a positive "Alert" saying: "the Reward is Excellent and the Risk is low - go ahead and Buy" - or - it gives a negative "Warning" saying: "the Risk is too High and the Reward is low to negative - do not Buy."
This is a brief explanation of how I go about making money in the stock market with an ever- present focus on both Risk and Reward Calculations.
This "Tradeoff" is presented graphically because: a) It is not understood very well by most Investors that I visit with personally and by Email. b) It clearly defines this axiom of the stock market and hopefully will get your attention as to its importance. c) It can accurately be Calculated to avoid or prevent investing in a highly probable losing security. And much, much more ...
I sincerely hope you will want to know more. If so please feel free to let me know with your questions and thoughts. My job is to make you money in the stock market with Tools like this in my direction and guidance of your future financial success.
My Email address is: email@example.com
Smile, Have fun, "Investing Wisely,"