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  • Evaluating Risk Vs Reward With Kelly 16 comments
    Aug 15, 2014 3:13 PM | about stocks: TNXP

    BESTFIT data is fast approaching for Tonix Pharmaceuticals (NASDAQ:TNXP) and we got a question about evaluating the risk vs reward, so we wanted to do a quick post about the Kelly Criterion.

    This is a formula that prescribes the optimal % of assets to wager given the risk vs reward:

    a formula used to determine the optimal size of a series of bets. In most gambling scenarios, and some investing scenarios under some simplifying assumptions, the Kelly strategy will do better than any essentially different strategy in the long run (that is, over a span of time in which the observed fraction of bets that are successful equals the probability that any given bet will be successful). It was described by J. L. Kelly, Jr in 1956

    Some more:

    The History
    John Kelly, who worked for AT&T's Bell Laboratory, originally developed the Kelly Criterion to assist AT&T with its long distance telephone signal noise issues. Soon after the method was published as "A New Interpretation Of Information Rate" (1956), however, the gambling community got wind of it and realized its potential as an optimal betting system in horse racing. It enabled gamblers to maximize the size of their bankroll over the long term. Today, many people use it as a general money management system for not only gambling but also investing.

    So given the probability of an event, and the ratio of the upside vs the downside of that event, the Kelly formula prescribes the optimal % of assets to wager.

    Here's the Formula:

    % to wager = [(R times W) - L)] / R

    R is the Ratio of the upside vs the downside

    W is the probability of Winning

    L is the probability of Losing (which is calculated as 1 − W)

    For example:

    Let's say someone gives you favorable 3 to 1 odds on a coin flip, what do you do? Things are clearly in your favor, but you still have a 50% chance of losing. Let's ask Kelly:

    The W and L are both .5 because there is a 50% chance of predicting a coin flip (1 would be 100% chance), and the R is 3 (upside to downside is 3:1).

    % to wager = [(R times W) - L)] / R

    % to wager = [(3 times .5) - .5] / 3

    % to wager = [(1.5) - .5] / 3

    % to wager = 1 / 3

    % to wager = 33.3%

    So if somebody gives you 3 to 1 odds on a coin flip, Kelly says you should bet one third of your assets.

    What if it is 10 to 1 odds on a coin flip? So tempting, yet a 50% chance of losing. Kelly?

    % to wager = [(10 times .5) - .5] / 10

    % to wager = [(5) - .5] / 10

    % to wager = 4.5 / 10

    % to wager = 45%

    A big chunk, but more than half stays safe.


    So we can apply this to Tonix at each step of the way with a (1) post-data price target and (2) odds of good data.

    R is calculated:

    Price Target on Good Data / (Current Price - Price Target on Bad Data)

    All for now, one caveat is that we think the Kelly formula is a good input, but nothing like the final word, which of course should have more to do with one's own personal risk tolerance.


    We happen to think the odds of good data are considerably better than 50%, we are not trying to imply anything with the coin flip example.

    Disclosure: The author is long TNXP.

    Stocks: TNXP
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Comments (16)
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  • Buddy Wise
    , contributor
    Comments (218) | Send Message
    great equation -


    keeping the PT = 45, current price at 15 and odds of winning to be 50% (just to be conservative)


    R = (45-15)/15 = 2
    W = .5
    applying the formula


    (2*.5 - .5 )/2 = 25%
    means 25% of your assets can be placed in this bet .


    however if the PT increases to $60
    33.33% of your assets can be placed in this bet.


    Let me know what do you guys think ?


    Note that 25% or 33% should be considered to be 25% or 33% of your speculative cash, not of your entire portfolio.


    Cheers !!!
    15 Aug 2014, 03:54 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » Actually you receive 3 for 1 in that example, I need to update the last portion to be just:


    Price Target / Current Price


    It's updated now, so your %'s would actually be higher. In addition, this models a total loss on bad results, which is very unlikely, even if all of their programs are valued at zero they have more than $4 in cash per share.


    For a bull it really says bet a lot - like you said it should be a portion of what can speculate with, and like I said your own personal risk tolerance is more important.
    15 Aug 2014, 04:02 PM Reply Like
  • Buddy Wise
    , contributor
    Comments (218) | Send Message
    I wanted to know how did you come up with the fact that R = price target / current price,


    from what I understand -


    R is the Ratio of the upside vs the downside


    if upside is let's say 45 or 60, downside should be something that's much less than the current price, say $10 or so, in that case the percentage would be even higher, so I kind of feel that R is not defined correctly here ?


    Accordingly this formula would encourage us to put more money if the downside is more.


    Don't you think it should discourage us from putting more money if there's more downside ?


    Let me know what do you think ?
    15 Aug 2014, 08:02 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » Thank you Buddy Wise, you are right, and wise, and quite a buddy, I updated it again, thank you:


    R is calculated:


    R = Price Target on Good Data / (Current Price - Price Target on Bad Data)




    I'll use my $77 share price for price target on good data, even though I don't think the stock would go to $4 no matter what I'll use that as a bad data target because they have that in cash.


    R = Price Target on Good Data / (Current Price - Price Target on Bad Data)
    R = 77/(14-4)
    R = 77/10
    R = 7.7
    17 Aug 2014, 03:15 PM Reply Like
  • jankrouham
    , contributor
    Comments (60) | Send Message
    Thanks for the formula!
    15 Aug 2014, 04:25 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » You are most welcome jankrouham, Chris DeMuth Jr.'s article is linked at the top where he reviews a book on the subject if you are interested in further reading.
    15 Aug 2014, 04:29 PM Reply Like
  • Dennis R. Mahon
    , contributor
    Comments (449) | Send Message
    Thanks Joe... I like the Kelly Criterion... looks like I need just a little more $TNXP. We have to salivate over a 3X or 4X possibility within 45 to 60 days... and act carefully and accordingly. Now I also need to look at what the formula will tell me about $MNKD and $ADMP. As far as $HYGS... I'm pretty sure I'm right where I need to be. Weekend of handicapping probabilities and math ahead.
    15 Aug 2014, 04:25 PM Reply Like
  • genoa93
    , contributor
    Comments (118) | Send Message
    Joe, really a perfect dump at 13.10 $ from descending trendline crossing 13th January and 01th July tops. Now lateralize and then... Next big resistance is 21 $!
    15 Aug 2014, 05:46 PM Reply Like
  • joedct47
    , contributor
    Comments (9) | Send Message
    I agree completely that investing is all about the ratio of the risks to the rewards. However, I think it’s the calculating of the real risk percentage and the likely rewards percentage which gives most people big trouble.


    In particular, I don't think most investors are looking at the risk with TNXP correctly. In this situation, as Joe Springer has tried to explain, I believe TNXP is quite a low risk bet. Note: I'm not saying zero risk because as with any investment all kinds of unexpected things can happen.


    Dr. Lederman and the other "wicked smart" docs and experienced money men have NOT made TNX-102 SL in the Fibromyalgia market their pivotal (bet the firm) first product by accident. They are smart and very experienced people and I believe they had good reasons for going with TX102-SL in the Fibromyalgia market instead of other products and markets they could have chosen.


    They didn't develop TNX-102 SL and decide to launch it and bring it to market without some determinate testing first. Go back and read the results of the clinical double blind testing they have already done on oral CBP (Cyclobenzaprine). They have done clinical testing and they got quite good results. Since they have done successful clinical testing on oral CPB before and now the sub-lingual form has been scientifically crafted to be more effective than the oral form, I believe the chance of "poor results" is extremely low.


    The million dollar question (literally) is what made TONIX pick this formulation and choose the Fibromyalgia marketplace. My experience with investors of all types including entrepreneurs tells me they believed they had an "edge" (possibly one that they legally cannot talk about.) Personally, I think they likely had some really good limited non-clinical testing results with the sub-lingual formulation and that is one of the reasons they were then able to attract such high caliber doctors, businessmen and board members. These top caliber guys did not join the company because they saw poor potential in this product or this company. (Note: This non-clinical testing stuff is all supposition on my part. I have no inside information on any testing, whatsoever.)


    Because we are dealing with a drug (NYSEMKT:CBP) with a well-known track record and given all the positive public information that is available I agree with Joe Springer and think the likelihood the upcoming TNX-102 SL testing will be very positive is very high. I would say it is over 90%+ likely to have good results. What I am saying is the upcoming test result is NOT a 50/50 pass/fail event. I believe the deck is completely stacked in favor of “good to great” results. I believe the only chance of bad results would be from some completely unexpected happening. To me that meets the definition of low risk.


    Joe Springer has already laid out an amazing array of information about possible rewards. Read Joe Springer's Instablogs and the accompanying comments. Some may think he is overly optimistic but he has explained the basis for each of those valuations and nobody has really poked holes in them. Yes, some have disagreed with those valuations but I have not seen anyone say why they could not happen.


    The bottom line is that TONIX has a great team and step by step, they are hiring the right people and the right support companies to make this into a blockbuster company. Their management team is pretty much the dream team that you could put together in this field. Then they have hired top-notch firms like EisnerAmper (top Wall Street accounting firm) and Ropes & Gray (Law firm that filed the patents for OxyContin for Purdue Pharmaceuticals, and those patents lasted until they ran out).


    1. The upcoming results are basically a redo (albeit with a different formulation) of already completed testing.
    2. They've got products that meet a well-established need.
    3. The products each have a huge market.
    4. They have a terrific development and management team.
    5. They are consistently doing the right thing.
    6. They are already well funded for the next two years.


    As the old saying goes, "You can lead a horse to water but you can't make him drink." It's just a fact that some people are more cautious and/or fearful than others are and it will take them much longer to see the low risk and the huge potential of TNXP. This could mean a big advantage for serious investors who have correctly calculated the actual risk and likely rewards. I think Tonix is one of the best examples of a low risk – high reward investment you are likely to see for quite a while.


    A special thank you to Joe Springer for all the great articles and great information. And thanks also to Jason Napodano for his informative articles.
    15 Aug 2014, 06:32 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » Wow joedct47, thank you for all of that.
    17 Aug 2014, 03:19 PM Reply Like
  • Jeb Walport
    , contributor
    Comments (961) | Send Message
    Then, to strictly apply rhe Kelly formula, one should sell all holdings at the PT used in the formula? In other words, the hand must be closed in order to optimize the investment strategy?
    16 Aug 2014, 10:06 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » If you still have that same price target that would be correct Jeb.
    17 Aug 2014, 03:21 PM Reply Like
  • Robert K. Stuart
    , contributor
    Comments (166) | Send Message
    Have there been any analyst initiations coming out of the recent investor conferences? If not, why wouldn't analysts be picking up on this?
    17 Aug 2014, 01:29 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » There are so few shares available, analysts work for big funds (buy side) and brokers (sell side).


    Buy side: If they like the stock they have anti-motivation to spread glowing views, their fund may want to buy it, so there is incentive to try to spread negative views, and some unscrupulous funds may do that.


    Sell side: If they want their brokers to be able to buy and sell the stock for fees or after doing some institutional banking then they have incentive to spread glowing reviews, but Tonix has about 1/400 of the shares of KO for example.


    And then neither group is known for its bravery, there is little incentive to make predictions.
    17 Aug 2014, 03:55 PM Reply Like
  • Robert K. Stuart
    , contributor
    Comments (166) | Send Message
    Thanks Joe. I learn something new everyday. In regards to outcomes, how would you compare your confidence to the + outcome of the BESTFIT trial data to your confidence in the MNKD pIII and FDA acceptance?
    17 Aug 2014, 04:29 PM Reply Like
  • Joe Springer
    , contributor
    Comments (2650) | Send Message
    Author’s reply » MNKD had it way harder, they had a device (which always complicates matters), and they had to dose along with the patients being dosed with a different type of insulin at the same, which can and did throw the numbers off, plus so many variables of people feeding themselves and then how much activity they engage in. There are no behaviors like that to control for while people are sleeping, and there are no other drugs to skew things. MNKD was also dealing with a life and death condition and drug whereas CBP has decades of safe use at much higher doses to show it is indeed very safe. Additionally oral Afrezza was never available off label (does not exist), and anecdotally and in surveys off label oral CBP corroborates Tonix' approach very well (and of course their statistically significant improvement in 3 symptoms in the 2a trial). Throw in that the FDA named FM as a disease for special regulatory treatment and Tonix seems to have a much lower hurdle to jump.
    17 Aug 2014, 04:39 PM Reply Like
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