Upside vs Downside

One my main metrics for buying any stock is the idea of upside vs downside. This basically means how much could I gain vs how much could I lose. On top of the "amounts" to be gained or lost is the likelihood of each happening.

To put this more into practice, here are two scenarios.

Scenario One
Stock price = 10c
Likely downside of 6c
Likely upside of 15c
Likelihood of upside of 50%

Scenario Two
Stock price = 10c Likely downside of 8c
Likely upside of 20c
Likelihood of upside of 40%

Both scenarios should provide value, but even though there is less chance scenario 2 will be to the upside, the rewards are greater, and the risks are smaller.Overall scenario 2 has the better risk vs reward profile.

Scenario 1 on average will return 10.5c for 10c invested. Scenario 2 however will return 12.8c on average. This can be easily seen if 10 trades of the same profile were completed.

In scenario 1, 5 trades would return 6c (30c total), and 5 trades would return (75c total). The 10 trades in total would return $1.05 (an average of 10.5c).

Scenario 2, 6 trades would return 8c (48c total) and 4 trades would return 20c (80c total). The 10 trades would return ($1.28).

Understanding upside vs downside is a key component to successful investing. Even though we had less wins in the above scenario 2, it was the much better strategy.