Technical Temptations Explained - Part IV - Risk Rewards and Stop

In this post we will look at price targets and risk reward ratios. When I buy a stock wouldn't it be nice to know what would be the potential price target? Technical patterns try to predict the price to which the stock might move. Sometimes price targets are attained but not always, so it is just a potential reward that you might expect.

For bull flags, the price target is the length of the pole, put at the point where trend line is broken. So, for XOMA that gave us a price target of 3.95 as shown in figure 1. And, good that the stock moved higher than that. So, that tells you, attaining price target does not mean you have to sell right away, but be more watchful, be prudent, manage your stops well.

When the flag is a steep declining one, then sometimes initial target might be treated as the top of the pole.




Figure 1: XOMA 1 month chart

And what is your risk. It is where you have put your stop.

So if you buy at 3.48 and put your stop at 3.35 and your potential price target is 3.95. Then you are risking 13 cents to potentially make 47 cents. That gives you a risk-reward ratio of 47/13 = 3.6:1 which is very good.

Anything above 2:1 is considered a favourable risk reward ratio.

When trying to figure at what price to buy and where to put my stops, I look at 10 day, 5 day - 15 min charts to give me better idea. Then as the stock starts moving I keep raising my stop to most recent lows, as shown in figure 2. Then if I see price/volume action weakening, I sell some.




Figure 2: XOMA 10 day chart

Always wait for the stock to clear resistance before buying. Don't let emotions come into play. I liked SSTR so much and I was so worried that I will miss the trade, that I bought it way prematurely, it was not ready yet, so I came back to my senses and got out, thankfully a bit above breakeven. If you look at 5 day chart, it needs to clear 4.23-4.24 before even considering it. Problem with buying early is, some stocks never clear resistance and just sit there for months or head down!


Some technical trading rules/discipline guidelines that might be of help:


http://www.thestockbandit.com/TradingRules.htm


http://www.chartpattern.com/10_golden_rules.html


Next we will talk about trade and list management!



Cheers!
Lazy