Sometimes people will reach out to us wondering: aren’t short term trades risky?
These folks are correct…..short term trades are risky.
You know what else carries risk…
Everything worthwhile in the stock market and in life!
It is therefore not a question of avoiding risk, but assessing and managing it.
We talked about the “risk management” in a recent article, specifically pertaining to cutting losses.
While that’s important, it is also helpful to know how risky a specific stock is before entering a position.
The “risk” by itself isn’t a very useful metric though…
We need to know how much it is relative to the potential reward! 🏆
What do we mean by “risk” and “reward”?
Reward- How much potential upside a stock has from its current price.
Risk- How much potential downside it has from the current price.
In “absolute” terms, the potential reward for buying stocks is always infinite and the risk is the dollar amount spent (assuming no leverage).
In practice though, neither of these scenarios are very realistic…
This is where the price action history comes in handy!
We can use effective support and resistance levels to gauge the “expected” upside and downside potential.
Let’s use AMD’s recent price action as an example…
Assuming we are looking for a short term trade opportunity, we want to use a shorter-term time frame to assess our effective support and resistance levels…
We can see that based on the stock price at the time of writing this, there is around $8.7 of potential reward and $10.8 of potential risk…
It is important to keep in mind that this is purely based on the price action.
There are many other factors to keep in mind when analyzing risk/reward, but this is one of the easiest to quantify.
It may take sometime to get the hang of it…..so just keep practicing!
That’s all for now.
Until Next Time,