Balancing the Tightrope of Risk and Return

adamMy wife is generally a play-it-safe type of person.

One of my favorite stories she tells is of when she was around five years old.

Her parents took her on vacation to the beach, but before she would agree to touch a toe in the ocean (albeit while sitting safely atop her dad’s shoulders)… she asked: “Dad, what’s the scariest animal in this water and what’s the worst thing it could do to me?”

I’ve always thought that’s a funny, somewhat morbid, question from a five-year-old. But a wise one, nonetheless.

Given my wife’s innate risk-aversion, you might imagine how our conversation went when she curiously asked me about stock options.

“What happens if you’re wrong,” she asked.

“I’ll lose money,” I replied.

“How much,” she followed.

“Potentially all of it,” I admitted.

And that’s about where our conversation ended.

Of course, there’s more to this story. And today I want to walk you through one of the most important concepts in investing – particularly, the type of investing that I do in my Cycle 9 Alert research service.

The concept is the asymmetry of risk and return.

See, my success with Cycle 9 Alert, now five years running, comes down to three simple concepts. I’ll discuss the first two with you today, but the third is a bit more complex, and needs more space to be explained so look out for that in my article next week.

Let’s jump into the first two concepts…

Better Than a Coin Toss

Economist Lacy Hunt, Ph.D. gave another brilliant talk at our Irrational Economic Summit this year. During his Q&A session, he talked about how the Federal Reserve’s economic forecasts have missed by a wide margin for seven of the last seven years. And that’s despite the Fed ponying up the largest research expenditure of any financial institution in the world.

Dr. Hunt quipped that the Fed could immediately improve its forecasting ability… get this… simply by flipping a coin. If heads, the economy will grow… if tails, it’ll contract.

It’s a preposterous idea. But it holds an interesting insight. That is… with so many complex and moving parts, predicting anything in financial markets – with results better than a coin toss – is actually extremely challenging.

Now, as a practical matter, it’s absolutely possible to make money over time even while winning fewer than 50% of your trades. But psychologically speaking, I’ve learned that very few investors have the stomach to trade a strategy that wins less than half the time.

That’s why I’ve always favored investment methodologies with win-rates better than 50%.

Cycle 9 Alert, I’m proud to say, sports a win-rate of 68%. That means that for every 10 trades we make, we win about seven of them and lose about three.

This is a very favorable win-rate. And it’s not just a fluke… my subscribers have earned this win-rate record after making more than 100 trades spanning the last five years.

Bottom line: Since we win more often than we lose in Cycle 9 Alert, my strategy is fully able to absorb and overcome the losses we may suffer when a trade sours.

Our Winners Are Bigger Than Our Losers

The second factor that explains Cycle 9’s success has to do with the size of our wins (when we win)… relative to the size of our losses (when we lose).

Recall that I mentioned it’s possible to make money over time, even if you win fewer than half of your trades. That’s true… but only if your strategy captures BIG winners, relative to the size of your losers. Otherwise, the math simply can’t work in your favor.

For example, if you run a strategy that only wins 33% of the time, your winning trades have to be TWICE as large as your losing trades, just to break even.

Now, Cycle 9 Alert is NOT that type of low win-rate strategy. Since our win-rate is well above 50%, we could, in theory, take “small” winners and “larger” losses.

But here again… we’re able to do better. Since inception, Cycle 9 Alert’s average winner has resulted in a 77% profit, while the average loser has amounted to a 67% loss.

These two variables, combined, explain the success that my service has had over the last five years:

• We WIN more often than we LOSE; and
• Our average PROFIT is BIGGER than our average loss.

Taken together, this is how my strategy continues to pull profits from the market year after year, and with a similar strategy, so can you.

There’s one more factor, related to the asymmetry of risk and return, which explains the long-running success of Cycle 9 Alert. That is, our ability to invest with completely limited risk. Again, I’ll dive into that subject when I write to you next week.

In the meantime, take a closer look at the inner workings of my Cycle 9 Alert strategy here to see how it could help you.

To good profits,

Adam_Sig

Adam O’Dell

Editor, Cycle 9 Alert

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Categories: Investing

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.