How to Assess Stock Market Risk vs Reward (2024)

Investors have a well-documented history of buying high and selling low. Why? The investing crowd feels safe near the top and scared near the bottom. That’s why investors need an objective, non-emotional risk/reward analysis like the Risk/Reward Heat Map (RRHM)

The RRHM is essentially a sophisticated 'pros and cons' list that visually expresses whether risk or reward will dominate over a specific time frame.

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RRHM Methodology

• The calculation starts with identifying a unique event.

• Once the event is identified, we look for past events (or occasions) that fit the same or similar criteria.

• Once past events are identified, we calculate the forward performance (for each individual event) for the next 1, 2, 3, 6, 9, 12 month.

Here is an actual example of an event and the resulting forward performance:

On June 10, 2020, the 20-day SMA of the CBOE Equity Put/Cal Ratio fell below 0.50, a very low and rare reading.

The chart below plots individual (and average) forward return of the S&P 500 after the CBOE Equity Put/Call Ratio (20-day SMA) fell below 0.51. The original study was published in the January 12, 2020 Profit Radar Report. The performance tracker at the bottom of the chart shows the forward performance for the next 1, 2, 3, 6, 9, 12 months and the odds of positive returns over the same time frames.

The subsequent studies follow the same pattern.

S&P 500 after the biggest rallies from a 52-week low (March 26, 2020 Profit Radar Report):

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S&P 500 after more than 90% of volume goes into advancing stocks 2 out of 3 days (April 12, 2020 Profit Radar Report):

S&P 500 after the first earnings season after a >30% decline (April 19, 2020 Profit Radar Report):

S&P 500 after percentage of NYSE stocks above their 50-day SMA rallies from <10% to > 90% (May 27, 2020 Profit Radar Report):

S&P 500 after falling more than 20% below 200-day SMA and subsequently closing back above the 200-day SMA (May 27, 2020 Profit Radar Report):

Nasdaq Composite after falling >20% from an all-time high and subsequently trading within 2% of preceding all-time high (June 5, 2020 Profit Radar Report):

S&P 500 after declining 30% and subsequently retracing 78.6% of that decline (June 7, 2020 Profit Radar Report):

S&P 500 after retracing 78.6% of any ‘sizable’ (7% or more) decline since 2009 (June 7, 2020 Profit Radar Report):

S&P 500 after two consecutive days with 89% or more of volume going into advancing stocks (June 14, 2020 Profit Radar Report):

S&P 500 after 3-day up volume drops from >60% to <15% (June 14, 2020 Profit Radar Report):

S&P 500 after CBOE Equity Put/Call Ratio (20-day SMA) falls below 0.51 (June 21, 2020 Profit Radar Report):

Shown above are only 10 of over 300+ studies (about 50 studies are added every month) included in the Risk/Reward Heat Map (RRHM). The RRHM visually tracks significantly bullish (green column = 80% or higher odds of bullish returns over the next 1, 2, 3, 6, 9, 12 months) or bearish (red columns = 50% or lower odds of bullish returns over the next 1, 2, 3, 6, 9, 12 months) forward returns.

The RRHM below was published in the January 15, 2020 Profit Radar Report with the warning that: "Based on our risk/reward heat map, we are approaching a pressure period, resistance in time so to speak, a period of increased risk in January and February."

Updated studies, Risk/Reward Heat Maps, projections, analysis and buy/sell recommendations are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron's rated iSPYETF as a "trader with a good track record" (click here forBarron's evaluation of the Profit Radar Report).The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.