Page 400 - THE MARKET WHISPERER

396 PART 11 - Risk Management
stocks with a good RR means you need to accumulate no small amount of
battle experience.
Calculating the Risk to Reward Ratio in Aon PLC, AON

Aon gapped down at the open, then continued dropping, found support
at $39.15, rose to $39.34 [2], executed a reversal to lows and broke support
[1]. This was also the point where I entered a short. But before entering, I
calculated the risk/reward ratio as follows:
• First, where is the stop? That’s easy: it is without any doubt above the

reversal point [2]; in other words, 20 cents above the line of support,
the short entry. But this is just half the answer.
• To complete the calculation, I need to estimate where the target is.
Glancing at the chart, we can see the outcome in retrospect. Aon
dropped to $38.32 [3], which is 82 cents below my entry point. We can
see that the RR was 1:4, in other words, I risked 20 cents and I could
have profited 82 cents.
Of course there are none so wise as those with hindsight, but clearly I
did choose a correct stock with an excellent RR. Could I have known where
the target was, and what risk/reward ratio could be expected in the final
outcome? To determine the answer, I need to examine the stock’s intraday
volatility over the last few days of trading: no better tool for that than the
daily chart.