Calculating Reward & Risk | Podcast Episode #389

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Hey, I’m Ryan Mallory and this is my Swing Trading the Stock Market podcast. I’m here to teach you how to trade in a complex, ever changing world of finance.

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Learn what it means to trade profitably and consistently, managing risk, avoiding the pitfalls of trading, and most importantly, to let those winners run wild.

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You can succeed at the stock market, and I’m ready to show you how. Hey everybody, this is Ryan Mallory with swing trade in the stock market.

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In today’s episode we’re gonna talk about calculating risk and reward and all of our trade setups. So today’s e-mail comes from a person.

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He recently joined the SharePlanner trading block and he had a question about one of the rules. It was rule #4.

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And on my Discord, I have like 18 rules that I’m pretty passionate about when it comes to my trading.

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A lot of do’s and don’ts. And #4 is I will pass on any trade setup that doesn’t offer me a solid reward for the risk that I’m taking a minimum of two to one.

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So the question here comes from a guy and we’re not gonna use his real name, we’re gonna call him Mabel, good Florida redneck name Mabel.

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And Mabel asks, how are you calculating a risk reward ratio?

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Now you can call it risk reward ratio or you can call it a reward to risk ratio. I tend to call it more of a reward to risk ratio.

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And why is that instead of risk reward? And it’s for the simple reason of when I talk about the reward risk ratio, I say, oh, it’s a three to one ratio, reward risk ratio.

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But if I said three to one risk reward ratio, I’d be implying that I’m risking three times as much for every dollar of reward I’m hoping to get.

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So I always say reward risk ratio because I’m more than likely to screw it up in my own mind and start saying risk reward, but saying the bigger number, which would be the potential reward first.

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So I know that sounds kinda stupid, kinda lame, but that’s why I call it a reward risk ratio.

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So that when I’m using that phrase and when I’m telling you what the actual reward risk ratio is, I’m using the reward number first.

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And that lines up with the actual phrase itself. Hopefully you guys are still listening after I talk about that, but it’s just always been some kind of like pet peeve for me because most people say risk reward, I say reward risk, and I see a lot of people who will say risk reward ratio and they’ll say it it’s three to one.

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And so I’m like, are you risking three times the amount for every $1.00 of reward?

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So any case, and maybe I’m just imagining and maybe nobody actually does that and I’m just bloviating here on the podcast for no real reason, but any case, I call it reward to risk ratio. My minimum is 2 to one, Optimal is 3 to one.

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Now yeah, if I can get a four to one, a 5 to 1, heck, if I can get 100 to one return for the amount of risk, that’s great.

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Is it necessarily realistic? Not always, and we’ll get in a little bit into that later in this episode, but I set a target price and I’ve done a number of podcasts now.

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I’ve done a number of podcasts talking about target prices, setting stop losses, but there’s always a different way that somebody might look at it that requires another podcast on it.

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So I don’t mind doing it. And plus, if there is some redundancy, it doesn’t hurt to hear it multiple times.

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And studies will show the more that you hear something said to you or the more times you’re taught something, the more likely you are to retain it.

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So I don’t mind repeating myself at times. So the target price, that’s what everybody’s usually obsessed with when it comes to trade.

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What’s the target price? How high do you see the stock going?

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That’s also the reward aspect of the trade. And then I also get a lot of questions, like, I understand how you set your stop loss or the risk aspect of the trade, but I never understand how do you project where it’s gonna go when it hasn’t gotten there yet.

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And so that’s the target price. That’s the reward aspect.

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And ideally I want the price to blow past my target. I am not gonna sell the stock and get out of it completely just because it hits my target price.

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I think a lot of people do that. They make it like set in stone.

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It’s like, OK, if it hits my target price, I have got to sell it at that level. But you don’t.

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Ideally, you wanna be so wrong about your target price that it blows right past it and keeps on going higher.

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Now, it doesn’t mean that I won’t take some profits at my target price, but I’m not gonna necessarily just get out of it completely just because my target price has been reached.

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And so when I’m setting a target price for a stock, I’m setting what I believe is the path of least resistance.

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How high can it go before it really hits some heavy resistance? If I’m buying into a stock at $100 a share and I’m setting my stop loss at $97.00, and I see that there’s some heavy, heavy resistance at 101, probably going to pass up on it because then I’m getting into a reward risk ratio of one to three.

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That’s not good because I’m taking on three times the amount of risk for that potential dollar and it might get a dollar higher and then just completely fall apart and stop me out.

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That doesn’t make much sense, right? So we want something that’s at least 2 to 1.

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So in that case if I had bought a stock at $100 and I have a stop loss at $97.00, I wanna make sure that it at least has a path of least resistance to 106, then I’m getting a 2 to one return.

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Ideally it’d be great if it’s like 3 to one and I can say to 109 dollars a share. But one thing that we don’t wanna do is create these pie in the sky scenario saying, oh, I’m gonna buy in at $100.

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Yeah, I think, I think the target price for this is like 170.

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Sure, you you’ll get into trades in life if you do it long enough where you’ll get a stock that blows up 70% to the upside, it’ll go way past your estimates.

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But do we want to be setting that for our swing trades? No.

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And the reason why I say that is because it becomes a pie in the sky scenario. And honestly, after I get into the trade, I think very little of my target price.

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I really don’t put much thought into what my target price is. I can tell you all the time what my stop losses are from memory, but I usually can’t tell you what the target price is from memory.

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I usually have to go back and refer to my notes, and that’s because after I trade and I get into the stock and I’ve been able to justify the reward risk ratio being at least 2 to 1, preferably 3 to one.

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I’m not too worked up about what the target price is because I know that there is a clear path of resistance to a 2 to one or a three to one reward risk ratio.

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And I think one of the things that people get themselves into a lot of trouble with is that they tend to white knuckle their trades, meaning they want to hold on for dear life until it gets to that target price.

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So again, we’re talking about, you know, getting in at $100 a share of stock, ABC stop loss at $97.00 a share and we have a target price for one O 9 and it gets up to one O 8 and it starts to falter a little bit.

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It’s like no, no, not going to take any profits here. Can’t do it.

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It did not hit one O 9 till it hits one O 9. I will not take any profits and then you just start seeing it go to one O 710-6105 for instance.

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Perfect example of this was this past week an apple. So with apple you had this double bottom off of the 200 day moving average.

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Now initially I got into it for a different reason. I got into it because it was starting to bounce off of the 200 day moving average but after I got in it came back down and retested that 200 day moving average.

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And this is, I’m talking about the chart from January 2024 here.

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And so it tested it a second time, bounced and then broke out, confirmed the double bottom. I did multiple videos to subscribers like yeah, ideally because it has earnings coming up towards the end of the week, I would like to see it reach its target over about 19850.

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That would be the previous highs from December, the month before. And I’ll get completely out of it because I know I’m right up against the earnings. I’m not going to hold a swing trade through earnings.

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I’m going to be out of it. But then it gets to like 19650.

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We’re about two bucks away. Stock’s been up four days in a row.

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It looks amazing and it starts to falter first day, second day, and then on the third day it starts to break too hard to the downside.

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So I go ahead and close out the trade. I close the trade out at 19230 for a 4.8% return.

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Now it’s trading at 18739. And I would have given up most of my profits on that trade had I not gotten out a little bit sooner when I started realizing, hey, this stock is starting to fall apart, I’m going to go ahead and get out.

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It’s not like a light volume pull back anymore. We’re seeing the selling pick up.

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But I could have white knuckled and be like, heck no, the stock has not hit one 9850 yet. That’s what my target was.

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That’s where it has to get up to. But it didn’t.

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It fell a couple bucks short. And so when it comes to our target prices, we can’t say that this stuff is etched in stone.

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Now on the opposite side or stop losses, yeah, those things have to be etched in stone, but not on the target prices.

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Target prices, we may be completely wrong and it goes way past it, but we also can be wrong and it doesn’t quite get there.

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So what are you gonna do? You’re gonna say, hey, they hit my target price, I’m gonna stay in it and take a loss because the trade’s not working out the way I expected when I originally got in?

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No.

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When it comes to risk management, yes, you stayed disciplined when it comes to target prices. If it’s not gonna hit it and it starts to fall back, don’t give up your reward aspect of the trade.

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Take the profits and go on.

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And another thing that you wanna remember going back to the Apple example, you know, I was playing it originally for the bounce off of the 200 day moving average. I got into it and it started to pull back.

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It looked like I was going to get stopped out of it, even test the 200 day moving average and it balances higher and then it confirms the double bottom and shoots higher from you know like 187 where it broke out at all the way up to 19650 and that wasn’t even the pattern that I originally got in for.

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And so when we get into trades, we have to be cognizant of price action changes over time. And with that we have to be aware of new levels of resistance that can form.

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There may be some resistance that wasn’t there before that is now there once you’re in the trade and you have to account for that and it could be that it creates a whole new layer of resistance that wasn’t even in development before.

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So price action changes.

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It changed for me on the Apple trade where I get into it off of a bounce, off the 200 day moving average pulls back tests, it bounces again.

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I have a double bottom on my hand. Yes, that was a favorable change in the price action that worked out in my favor.

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But you can also have price action that works against you. I’ve seen it before where you’ll have these trend line bounces and these suck, not the trend line bounces themselves.

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But that’s what I’m about to explain to you.

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You’ll get a pull back to this rising trend line looks really good, but then it starts to form time on this trend line.

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And now when you’re retesting a rising trend line, that means it’s pulling back. OK, so there’s been some we’ve lost some price from the previous highs, but then it doesn’t immediately bounce.

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It doesn’t give you that V shaped bounce that we all crave off of the rise in trendline.

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Instead, it stays there. It might move a little bit higher, but it doesn’t move dramatically higher and it just kind of goes sideways, hugging that rise in trendline.

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But then all of a sudden in the process, it’s formed a bare flag.

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So you gotta be aware of the fact that hey, this might not be the most bullish pattern that I originally set out for.

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And instead it’s forming this bearish pattern and if it breaks to the downside, may not even wanna wait for my stop loss to be triggered.

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Go ahead and get out because the price action has changed. Now, if something develops favorably, that doesn’t mean that you widen your stop loss because then you’re being undisciplined and you’re going ahead and increasing your risk, which is something that you should not do going into a trade.

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And I talked about before why I’m not overly crazy. I mean, sometimes you can find this trade setup that might offer like A5 or a six to one return and that’s great.

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If you can find them, they’re not as common as you’d like.

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I mean, if you’re looking for a, for instance, like if you’re looking at a 12:50 return, then if you’re risking 3% on your trade setup, you’re looking for a 30% return. 30% return is difficult when it comes to trading stocks.

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And I get that there’s options and that you can get a whole, you know, some really crazy returns trading options.

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But when I’m just talking about trading stocks, the equity 30% is pretty difficult.

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There’s got to be a pretty significant catalyst. Doesn’t mean it can’t happen.

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And when it does happen, that’s great. But that shouldn’t be really the benchmark that we set out for on every one of our trades.

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You get 3 to one or two to one on every one of your trades and you’re, you know, winning it. Not even 50% of the time.

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They’re gonna be doing pretty darn good in the stock market. So when I start seeing like 567 to 1:10 to 1:50 to 1:00, either one, their stop loss is too tight.

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Maybe they have a stop loss at like 1/2 percent. And so yeah, you can get some crazy reward risk ratios when your stop loss is less than 1% or they got a pie in the sky mentality.

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They’re hoping for something that’s not all that likely.

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I had someone in the trading block today asked me about EOG and what I thought of it. It’s an oil and gas play and had a pretty nice bounce of and it looked like it could continue in the days ahead and maybe it eventually does.

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But from a reward risk standpoint, it wasn’t offering the best scenario.

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You had three significant levels of resistance above the price and you had one just like a buck ahead of where price was sitting at.

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So if you got in at 1:15, there was some resistance at 1:16, and even if you were only risking like 3 or 4 bucks, that was not a favorable reward risk ratio.

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And even if you got the trade to breakthrough the 116 level, there was a lot of resistance at the 122 level.

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So there wasn’t a really good clear path of least resistance where the stock can move without being affected too much.

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There was a lot of resistance. So even though the stop loss was good, it didn’t equate to a favorable reward risk ratio.

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If you enjoyed this podcast episode, I would encourage you believe me, a five star review. Those things really do mean the world to me.

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They help me out to continue to build this audience and reach more traders like yourself. And if you have questions, don’t be a stranger, send me an e-mail ryan@shareplanner.com.

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I do read them all and I try to make an episode out of nearly every one of them. I would probably say 98 or 99% of them become a episode all into themselves.

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So send that to me. Send me your stories, Send me your questions.

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I want to hear about your background, your struggles, fears. Let me hear it ma’am.

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And again, leave that five star review. I appreciate it.

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Thank you guys and God bless, Thanks for listening to my podcast, Swing Trading the Stock Market. I’d like to encourage you to join me in the SharePlanner trading block where I navigate the stock market each day with traders from around the world.

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If you have any questions, please feel free to e-mail me at ryanshareplanner.com. All the best to you and I look forward to trading with you soon.