Quantify Your Reward Before You Trade

06/24/00 08:12:37 PM

by Jason K. Hutson

Plan out your investment before you make it. Make sure the end result is worth both the risk and time you put into it.

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Return is the most common way to measure the reward of an investment. Actual cash dollars are one way to quantify your returns, or you can calculate your yearly percentage gain. Mutual Funds commonly list their returns as percentages. For example "eleven percent since inception" means that from the beginning of the life of that particular fund your initial investment gained 11% each year. Percentage gain is calculated by dividing the amount of money you get out of the investment by how much money you put into it.

But how much do you risk in order to achieve a particular gain? What is the worst possible thing that could happen with your investment? You must always have a plan for every investment. You must define your entry and exit points before you invest, and never get attached to a particular investment or refuse to admit that you were wrong.

The importance of identifying your entry and exit points can be explained in the following example. Microsoft, the darling of many investors, dropped sharply in April 2000, falling below the $88 support level. This would have been an ideal exit point to identify before entering a trade. This minimizes the risk involved in your investment.

It is very easy to see in the beginning of April 2000 that Microsoft Corporation broke the $88 support level shown by the green line. This was an ideal place to pick your exit out of your Microsoft Corporation investment.

Graphic provided by: CQG.

Not only is the question of risk important in your investment strategy, but so is your time. Think of investing as a job and include not only the time you spend investing, but the time you spend planning and worrying about your investments. Different types of investments require various quantities of time to study and make decisions. If you need to be in front of your computer every day monitoring the stock market, you should count that time as part of your investment.

Now that you have an idea of how much time and risk you're taking, is it worth the potential reward? If your investment does not show signs of a considerable improvement on the yearly returns garnered by investing in government backed certificates of deposit or United States Treasury bonds, then save yourself the headaches and purchase one of them. In addition to being almost risk-free, US T-Bonds are backed by the government and might as well be considered the lowest common denominator for any investment you are considering.

Your actual reward is a combination of money earned in a particular investment time frame minus the difficulty in making those hard decisions. Picking a more conservative investment vehicle might eliminate those problems while keeping the same returns.

Jason K. Hutson

Traders.com Staff Writer. Enjoys trendlines, support and resistance, moving averages, RSI, MACD, ADX, Bollinger bands, parabolic SAR, chart formations, and volume analysis.

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Quantify Your Reward Before You Trade

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