Notes From The Editor

How To Calculate Risk/Reward

Risk management is the rock-solid foundation of any successful trading strategy. Sure, you can survive for awhile without it - but eventually your luck will run out, and your account will suffer the consequences. Embrace risk management, and you can set yourself up for the sort of ongoing trading success that eludes those with a more haphazard approach.

Part of this involves position sizing - or to put it plainly, not putting too much money on any single position. But that's only part of the game. The other pillar of risk management involves being very selective about the trades you take. The rule is simple: if the stock doesn't offer an acceptable risk/reward ratio, you move on to greener pastures.

The risk you assume on any trade correlates directly to your stop placement. For example, if you start a trade with a trailing stop of 3.00, this is your maximum risk. (The rare exception is an overnight gap past your stop - but again, position sizing should limit your losses when this occurs). A general rule of thumb for swing trading is to use at least double the stock's average true range (ATR); the ATR is the amount it typically moves in one session.

Reward depends on a stock's potential to rise or fall (for bullish and bearish trades, respectively). This isn't as cut-and-dry as determining potential risk. However, technical analysis can be a helpful and reliable guide. Look first for the nearest support or resistance levels. These are important lines in the sand, where buyers and sellers will meet to duke it out. Also look for moving averages and trendlines, which can also lead to price reversals.

So what constitutes a good risk/reward? Except for rare circumstances, such as playing a news event, you never want to take a trade that has a risk/reward ratio worse than 1:2. Ideally, look for a ratio of 1:2.5 or 1:3. In some cases, when a stock faces a large fast-move zone (an area where there's no support/resistance), the risk/reward ratio can be even larger! These make for great set-ups, and you'll find them often here in the RightLine Report.

Let's illustrate all of this with a few hypothetical examples. Imagine ticker XYZ is poised to clear strong resistance at 30.00. A breakout above that level could offer a great set-up - but only if it passes the risk/reward test. Based on its ATR of 80 cents, you know that your stop should be roughly 1.60. Then, you look at the daily chart to see how far the stock might run over the short-term. It turns out it's smooth sailing up until 34.75, which translates to about 4.75 of potential reward. This would equate to a risk/reward of roughly 1:3. Knowing this, you feel comfortable pulling the trigger and jumping onboard.

Now let's use the same stock, but with higher volatility. In this example XYZ has an ATR of 2.00, rather than 80 cents. Doubling that amount would mean that your initial stop would be 4.00. Risking 4.00 to potentially make 4.75? That doesn't sound like a winning proposition - and its risk/reward is much worse than 1:2 - so you move on to other trades.

The "art" behind calculating risk/reward comes into play when potential support/resistance levels are loosely-defined. This is when your own judgment comes into play. Will price action will reverse from that level, or will it continue on to another area of congestion? Let your own experience and traders' instinct help you answer that question.

Finally, if you can't get a firm handle on a set-up's risk/reward, don't hesitate to move on. In a market teeming with stocks, a bit of extra digging should turn up a candidate where your risk/reward is clearly defined and in your favor. Remember - the market will keep throwing pitches. It's you, the empowered and educated trader, that decides when to swing!

Here's to profits,

Kent Barton
Senior Analyst

Quick List

    
Stock     09/06     09/06      Buy      Short   Trailing Stops     Gain 
Symbol    Price      +/-      Entry     Entry   Initial/Tighten   Amount 
------  --------  --------  --------  --------  ---------------  --------

NOTV      20.45      0.14     20.92      19.5        1.42/0.71       3.2
VCEL      22.62     -0.07     23.16     21.39        1.77/0.89       3.9
SHLS      25.80      0.80     26.47                  2.68/1.34       4.1
WOLF     109.08      0.16     111.4                    9.2/4.6      9.74
ARRY      20.77      0.50      21.4     19.36        2.04/1.02      3.58

The "Quick List" provides a brief summary of each stock write-up and should be taken in the context of the related write-up presented in the "Stocks Covered in This Issue" section of this Report.

Be sure to read "How To Use The RightLine Quick List" and always use the RightLine Risk Control Calculator before entering any position.

For more on controlling risk go to the RightLine Risk Control System

For a glossary of terms unique to The RightLine Report go to: Glossary

Questions? Send us an email using our Contact Form.

Market Summary

Stocks were lower on Tuesday following a long Labor Day holiday weekend, as the ISM Services Index unexpectedly accelerated and the S&P Global U.S. Services PMI for August showed growth dropped more than expected. Traders are awaiting commentary from Fed Bank Chairman Powell and the Central Bank Beige Book report to be released this week, which should provide insight into how aggressive the Fed will remain to lower inflation. In equities, shares of ADT (ADT $8) were up after the company announced that State Farm Insurance will make a $1.2 billion investment in the home security company, which will give State Farm a 15% ownership stake. The USD/dollar and oil prices moved higher, gold and treasuries were lower, lifting yields.

                        Sep 5, 2022            Sep 6, 2022    
                  --------------------   --------------------
Dow                    Closed        0     31,145.30  -173.14
Nasdaq                 Closed        0     11,544.91   -85.96
S&P 500                Closed        0      3,908.19   -16.07

NYSE Volume                          0                  4.15B
NYSE Advancers                       0                  1,030
NYSE Decliners                       0                  2,194

Nasdaq Volume                        0                  4.64B
Nasdaq Advancers                     0                  1,464
Nasdaq Decliners                     0                  3,077

                                 New Highs/Lows

                   08/30  08/31  09/01  09/02  09/05  09/06
                 --------------------------------------------
NYSE New Highs        12     11     14     18      0     17
NYSE New Lows        147    160    252    101      0    222
Nasdaq New Highs      18     24     34     42      0     35
Nasdaq New Lows      256    227    425    217      0    398
   

TRADER'S TIP: "Market Mischief: Headfakes & Whipsaws"

Headfakes and whipsaws are terms used to describe market action with sharp price movement and abrupt reversals. This type of "yo-yo" action can cause a trader's stop to be triggered soon after a position is entered. Headfakes and whipsaws often result when market makers and other "deep pockets" push prices in one direction in an attempt to convince traders that the move is legit, then abruptly reverse the move.

Headfakes, whipsaws, and other false breakouts are a normal part of trading, so condition yourself not to let them frustrate you. Even the best-looking trade will blow up sometimes, yet it really doesn't matter because the loss is contained when you apply solid risk control. Just remember that we're playing a game of odds where the "edge" in our trading plan provides profits over time.

The Technical Analyst

For help with this chart, be sure to read "Understanding The Importance Of Support And Resistance"
and "Improve Your Trading With Moving Averages".

S&P 500 - 3908.19 September 6, 2022

52-Week High: 4818.62
52-Week Low: 3636.85
Daily Trend: DOWN
Weekly trend: UP
Weekly Pivot Levels
Resistance 3: 4282.31
Resistance 2: 4122.97
Resistance 1: 4023.61
Pivot: 3963.63
Support 1: 3864.27
Support 2: 3804.29
Support 3: 3644.95

NASDAQ Composite - 11544.91 September 6, 2022

52-Week High: 16212.23
52-Week Low: 10565.14
Daily Trend: DOWN
Weekly trend: UP
Weekly Pivot Levels
Resistance 3: 12924.11
Resistance 2: 12345.76
Resistance 1: 11988.31
Pivot: 11767.41
Support 1: 11409.96
Support 2: 11189.06
Support 3: 10610.71
        
Dow Industrials - 31145.30 September 6, 2022

52-Week High: 36952.65
52-Week Low: 29653.27
Daily Trend: DOWN
Weekly trend: UP
Weekly Pivot Levels
Resistance 3: 33894.70
Resistance 2: 32751.63
Resistance 1: 32035.03
Pivot: 31608.56
Support 1: 30891.96
Support 2: 30465.49
Support 3: 29322.42
 

Market Calendar

ECONOMIC REPORTS AND EVENTS (all times are Eastern):    

MONDAY, SEPT. 5 
Labor Day holiday - None scheduled  

TUESDAY, SEPT. 6 
9:45 am S&P U.S. services PMI (final) Aug
10 am ISM services index Aug 

WEDNESDAY, SEPT. 7 
8 am Cleveland Fed President Loretta Mester speaks 
8:30 am International trade balance July  
2 pm Beige Book 

THURSDAY, SEPT. 8 
8:30 am Initial jobless claims Sept  
8:30 am Continuing jobless claims Aug
10 am Quarterly services
3 pm Consumer credit July  

FRIDAY, SEPT.9 
10 am Wholesale inventories revision 

For a chart of typical Up or Down market reactions to specific major US economic reports 
go to:  Economic Indicator Effects

TRADER'S TIP: "Big Gaps, Big Potential"

Large upside breakout gaps can be very bullish and present a terrific buy opportunity. However, consider the move suspicious unless it takes place with heavy trade volume. The initial group of motivated buyers should attract enough attention to convince an even bigger crowd to join in. Be prepared to exit quickly if the volume doesn't support the price expansion.

Stocks Covered in This Issue

HEALTHCARE SECTOR

Inotiv, Inc. (NOTV: Healthcare/Diagnostics & Research) - SQUEEZE PLAY. NOTV traders on both sides of the fence are now locked in a head-to-head shootout. Tuesday's price range was the narrowest in over a week, as neither Bears or Bulls have been able to clearly gain the upper hand. This gives us an opportunity to catch the next directional move with little risk of loss. To do this we'll place both a long and a short trigger with a BUY at 20.92 and a SELL short trigger at 19.5. When one of the orders is filled, cancel the remaining order and enter a 1.42 trailing stop. When you've reached a 3.2 paper profit, tighten the stop to 0.71. NOTV closed at 20.45 on Tuesday. Earnings Report Date: N/A. Beta: 2.77. Market-Cap: 523.408M. Optionable.

Vericel Corporation (VCEL: Healthcare/Biotechnology) - SQUEEZE PLAY. VCEL shareholders know what it feels like to be squeezed. Tuesday's slim price range reveals uncertainty on both sides of the table, a situation which often resolves itself by either Bears or Bulls quickly gaining a clear advantage. The question is "who will win?" Near-term market action tell us whether we should sell short or we should buy shares instead. VCEL closed Tuesday at 22.62. The plan is to enter in the right direction by placing a BUY trigger at 23.16 and a SELL short trigger at 21.39. Once VCEL establishes direction, place your triggered order. As soon as you are in the trade, place a trailing stop in the amount of 1.77. After you've collected a 3.9 profit, tighten the stop to 0.89. Earnings Report Date: Nov 07, 2022. Beta: 1.98. Market-Cap: 1.067B. Optionable.

TECHNOLOGY SECTOR

Shoals Technologies Group, Inc. (SHLS: Technology/Solar) - BULLISH BOUNCE. Here is another example of a stock in an established uptrend that has recently experienced a counter-trend drop. The sliding price action has now found support near a moving average zone, bouncing upward during Tuesday's session to close at 25.80. Anticipate the rebound to continue, and be ready to buy SHLS at 26.47. Follow your entry with a trailing stop of 2.68 which can be tightened to 1.34 on a 4.1 profit. Earnings Report Date: Nov 07, 2022. Beta: N/A. Market-Cap: 2.907B. Optionable.

Wolfspeed, Inc. (WOLF: Technology/Semiconductors) - BULLISH BOUNCE. Up-trending stocks like WOLF have a tendency to bounce their way skyward rather than travel higher in a straight line. After touching down to a moving average support level on Tuesday, WOLF is poised to lift off again. To take advantage of this setup, prepare to BUY shares at 111.4 if positive price action occurs. As always, follow your entry with a trailing stop. A 9.2 trailer should work well with WOLF. Tighten it to 4.6 on a 9.74 gainer. Earnings Report Date: Oct 25, 2022. Beta: 1.73. Market-Cap: 13.537B. Optionable.

Array Technologies, Inc. (ARRY: Technology/Solar) - SQUEEZE PLAY. Sometimes when Bulls and Bears face off in the market arena for a typical day-long battle, there is no clear winner. This is evident when the daily price range contracts to an unusually narrow state. ARRY found itself in this condition on Tuesday when neither buyers or sellers were able to push ahead. This setup provides traders a chance to hop on board the next breakout - whether it's to the upside or down - with little risk of loss. To do this place a BUY order at 21.4 and a SELL short trigger at 19.36. When ARRY moves outside of Tuesday's range, one of the orders will be filled. Once you hold a position of shares, cancel the unfilled order and place a 2.04 trailing stop. After you've got a 3.58 profit, tighten the stop to 1.02. ARRY closed at 20.77 on Tuesday. Earnings Report Date: Nov 09, 2022. Beta: N/A. Market-Cap: 3.122B. Optionable.

IMPORTANT: Before entering any positions, always use the Risk Control System to determine the level of acceptable risk and the maximum number of shares to buy. Use Gap Adjusted Entries to reset the Entry Price for stocks that gap beyond recommended entry levels.

Stock Splits

Below are the stocks that have announced splits and have recently executed or will execute soon. There is generally a return to normal price behavior in the weeks following a split announcement in what we call a "Dormancy Phase." As the stock nears its split execution date (Effective Date) it often moves into the "Pre-Split Run" stage where quick and sometimes dramatic gains can occur.

                             Announce     Eff.       Split
Company Name     (Symbol)      Date       Date       Ratio   Options  
---------------- -------     --------    -------     ------  -------   
Nasdaq Inc        NDAQ       7/20/2022  8/29/2022    3-for-1   Yes
Tesla             TSLA       8/5/2022   8/25/2022    3-for-1   Yes
Palo Alto Net     PANW       8/23/22    9/14/22      3-for-1   Yes    

Split details are also available online at the RightLine Online Stock Split Calendar. For a detailed look at the different stages of a Stock Split, Click Here.

A simple yet powerful tool, the Risk Control Calculator helps you manage risk by recommending a maximum number of shares to purchase. Available in the RightLine Member's Area.

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