Just How Much Risk is There Really?
Risk a really hard thing to measure. No matter how not risky something seems, if it plummets on you the day you buy it (and it can) you will feel the investment was somehow more risky. One good way of measuring risk is by capturing the average stock price movement that is happening in the general buzz of the stock price. This is known as the true range. The true range is simply the highest high and the lowest low of the day. Obviously you don’t know what the range will be in the day you are trying to place an order so you need some form of history.
The average true range (ATR) is the average spread between high and low over some period in the past. Fourteen periods in the past is the most common used, but you should experiment to find what works well in your trading or investing style. What I use my average true range for is to determine my stop loss. I usually place my stop loss just outside the average true range. That way randomness doesn’t stop me out of a good trade. While this does tend to make larger stop losses than I would like, I’ve also increased my win ratio. The ATR is really good for sizing my trades. The smaller the ATR the more I’m willing to bet on a single trade.
As you learn stock market strategies try to keep in mind the implied risk of each tactic. It is easy to get carried away in the huge gains of some of the high flying trade styles. Remember that range, it is telling you that no matter how sure you are of the direction it can go in the opposite direction first. Having your money tied up in high ATR stocks isn’t a great money making idea either. Often you’ll find your stock buzzing around without any good opportunities to get out of it.
