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Odds of a Profit Target
By Jobo Smith
Odds of a Profit Target Most people can figure out generally a reasonable profit target, or a reasonable stop loss. What they don't take into consideration (or probably do, but its subconscious) is the ODDS of a profit target hitting. There are 2 dimensions here, TIME and PRICE. The more time you give it, the bigger the range in the stock generally, and the more it can move. For most short term traders, the holding time is generally a 30 minutes to 1-2 days max. Sure there might be exceptions, but as anyone who trades knows, any time you are in the market, you have exposed your money to risk. So the name of the game is to minimize this risk and make the most money possible while doing so. Odds are impossible to accurately figure out, but it is somewhat easy to get a ballpark figure. This can be done in excel as an exercise to learn, in reality you will just need to eyeball it - but this comes from experience and knowing what to look for. Here are the steps needed: 1. Take the last 5 days of price activity on a chart. Use a 30 minute chart. For each period record the high and the low.
2. Starting with period 1 (the oldest time frame back), go one period ahead to period 2 and then make a column where you take the (high of period 1) - (low of period 2). In addition make another column where you take (low of period 1) - (high of period 2). These are your risk columns.
3. Label the first new column "Long Entry Risk", and the second new column "Short Entry Risk.
4. On the long entry column - get rid of any negative numbers, if they exist (they can from gap openings) and delete that entry. On the short entry column, get rid of any positive numbers. We are only interested in bar to bar price action, ignoring abnormalities.
5. Once this is done, sum up and average each of the columns. This is your average max risk for a 30 minute period of time. The same can be done for longer periods, but requires more work. This is fine for this example. What we are going to assume is we are the worst possible market timer in the world. Meaning every time we go long, its at the EXACT high, or if we go short, its at the EXACT low. Since most of the time people will hold stocks for longer than 30 minutes, if the risk of just a 30 minute hold is beyond your tolerance for loss, find a new name. The average in the first column is your risk for going long. This is the average High to Low range, based of the prior periods high. So for example, if this average is 0.92, this means on average this stock will sell to a low point 92c below the high of the prior 30 minutes. This is reality, not a guess - sure its an average, but that is your basic risk. The same goes for the short column - this neg number is your risk from going short. This risk is just random stock volatility based on trading action and the market. Once you get a spreadsheet setup, its very easy to plug other numbers in and get a running list of stocks risk levels. These can be used to compute approximate odds. In the above example, if I go long the stock and use .20 stop, there is probably a 95% chance that would get hit, as the average range is 0.92. Now assuming we are mediocre in timing, we can probably get in at something other than the exact high point. This exercise also is assuming you are not out of the stock - it is not looking at the average run up in the next 30 min as well. This can be easily done by comparing the (high of period 2) - (high of period 1). This can then be averaged as well and then used to sort stock names. In general you would not want to go long a stock where the ratio between these 2 is less than 1 - that means it runs down further than it pushes higher. |
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