The best way to determine which chart is best for a particular trade is to think about your potential return on investment. The lower the risk, the more important the chart, and the more time the risk will have to pay for itself before you would sell. If you have to sell, however, you should still buy, even when you can afford to do so.
You should first establish whether you’re likely to be able to trade at a profit or loss, and then determine the level of risk your risk takers are comfortable with. A good way to determine this is to do what most investors do and calculate the expected return on an investment.
In a time of low interest rates, a high rate of risk and uncertainty, for example, a return of 2 percent may look good, but it would likely only last 6 months. If you’re comfortable with a 3 percent annualized risk, however, then you’re in good shape. A return of 6 percent is great for you – but you should pay a lot more attention to those 7, 8, and 9 percent returns.
Once you have an idea of the level of risk you’re comfortable with, then select the chart that best reflects that risk. In the worst case scenario, the 5th season chart is the best, while the worst case scenario is the worst-case scenario.
If you don’t have a specific chart to use in that context, you can create one for your own purposes. For example, you may want to buy a chart that shows the market’s worst-case volatility – for example, what the S&P 500 would be trading if you lost half of it.
For the sake of comparison, you would also want to consider whether your chart makes you feel uncomfortable about the possibility of losing half your money in a sudden flash crash.
How do you choose which chart to use?
I prefer not to use a chart that doesn’t clearly represent the risk of an investment. So I always use the risk-reward chart, as this represents the lowest risk. For example, the 5th season is the worst-case scenario, whereas the 6th season is the best-case scenario if the market falls by 10%. If the market’s falling by 20% on the 6th season, then the 5th season seems appropriate as well.
Once you determine the market’s expected volatility, you can determine the range of options that could return that much in the worst-case scenario – including the
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