Ask Colin

Do you consider Risk/Reward ratio important for choosing stocks to invest in?

I do not work with targets. This is for two reasons:

Firstly, I have problems with the whole idea that markets can be predicted. I can explain most things in the technical analysis I use in terms of the behaviour of buyers and sellers. However, predictions do not seem to have such a logical explanation.

Secondly, and much more important, is my fear that working towards a target blinds us psychologically. We tend to ignore evidence contrary to our prediction and only see confirming evidence. I find it is much healthier psychologically to keep as open a mind as possible and just react to what the market is telling us.

However, there is one respect in which I do take the idea of targets into account in a rough way and that is that in point and figure charting, the width of a trading range implies the scope for the price to move out of it. Thus, the wider the trading range, the bigger the move. Although I cannot explain why this works, I use it to the extent that I look for wide trading ranges rather than narrow ones. This puts the potential reward in my favour relative to risk.

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