When looking at the ideal time to buy or sell stocks, the investor must consider the asymmetric reward/risk relationship of each opportunity. This post touches on understanding asymmetric risk and reward in the stock market.
Essentially, the concept is around potential gains being asymmetrically greater than the potential losses with the greater the asymmetric reward to risk the more favorable the opportunity. On the other hand, the lower the asymmetric reward to risk the less favorable the opportunity.
We identify opportune entry and exit points with favorable asymmetric reward to risk profiles that get triggered when the market price of a security has reached its respective terminal extreme, and a reversion to the mean becomes more probable.
For example, at one market extreme an opportune entry point is triggered where the upside reward potential is asymmetrically greater than the risk to the downside. A security priced at 20 has the upside reward potential of 60 with a downside risk of 10.
At the other terminal extreme, an opportune exit point is triggered where the risk to the downside is asymmetrically greater than the upside reward potential. A security priced at 90 has the downside risk of 30 with an upside reward potential of 100.
Having a clear understanding of what exactly asymmetric reward/risk is can help your financial institution (hedge fund, family office, etc.) make the best, most informed decisions and if you have questions we’re here to help.