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Apr 30, 2007 - Issue #056

Risk vs Reward

DJ-30: 13120.94 +158.96 +1.23%. In the Real World: 53.82 +0.65 +1.23%.

UP: 18, Down: 12.

Trends (weekly): This is the subjective part.

Rising 19 (+1) 63%:

+*AA, +*AIG, AXP, BA, CAT, DD, DIS, +*GE, HON, HPQ, IBM, JPM, KO, +*MMM, MO, MRK, MSFT, T, XOM.

Consolidating 10 (-1) 33%:

C, -*GM, -*HD, INTC, -*MCD, PFE, PG, UTX, VZ, WMT.

Declining 1 (n/c) 3%:

JNJ.

+/- denotes change of direction.

* denotes change of category.

Risk vs Reward

We still don't know what this market has in store for us. It is moving up, but hesitatingly so.

Even if the trend remains up, how much further up? Is it worth the risk?

Some individual stocks have exploded to the upside. Is that the final "mark-up"? Some stocks have tumbled, usually due to earnings disappointments. Should they be bought on declines or shorted on rallies?

As far as the general market is concerned, are we nearer the top than the bottom? After all, this major uptrend has lasted since 2000.

These questions, and more, are faced by all market participants every day. How to cope?

Pondering whether to lighten up on existing positions or initiating new positions traders/ investors are faced with the problem of risk vs reward.

Money management is responsible for 65% of the results of any game you play. If your average gain is three times your average loss, this means you can be wrong two times out of three and still make money (do the math).

When evaluating a market candidate (long or short), first determine the maximum loss you're willing to risk. Then estimate if the profit potential is at least three times the amount of that risk. If you can't see yourself making at least that much, pass.

If there are options trading, compare each option's potential to the underlying market to see if you can gain leverage (more bang for the buck).

If there are single stock futures available, compare these as substitutes for the underlying. Examine all possibilities to maximize leverage while limiting risk.

No trader/investor can do more.