How do I Calculate Reward/Risk? $IIPR as an ExampleIn my recent "Trade Plotting" educational posts I have shared, I referenced scaling out of my position at 2.5x my risk and then closing my position at 4.5x my risk.
I had couple followers asking for clarification as to how do I determine my risk on trades and how does that translate into scaling out and/or closing out the entire position.
Its really straightforward. Before I put on any position, I know exactly where I am going to enter and exactly where my stop loss is, which means, I know exactly how much i am going to lose per share if the stock turns south on me. Knowing how much per share I am going to lose drives the size of my position and therefore, defining my exact risk in dollars.
Knowing that, I use Fib Retracement tool to project upwards (in case of a long position) my reward multiples. For clarification, I labeled these as R1, R2, R3, R4 and R5 (R = Return) on the chart.
Remember that the tighter the distance is between your entry and your stop loss (AKA having a tight stop loss), the faster the stock is going to hit your R targets and the wider the distance between your entry and your stop loss, the more distance the stock has to move up to hit your Rs.
I normally take half my position anywhere between R2 and R3. If I enter with a very tight stop (distance between Entry and Stop very small) because I am expecting the stock to start its run very soon after I enter, I normally hold on to the entire position well beyond R3 (as the distance to get there is relatively short).
Hope this helps, if you have any questions, firing them off in the comments below. Thanks!
