Do you consider yourself as a risk-taker? If you are in the stock market and trading stocks, among the safety measures that you can use is risk/reward calculation. You’d be surprised how easy it is to do the calculation. What you have to do is just divide the net profit by the price of your max risk and that is it!
Realizing what is Reward from Risk
Unfortunately, retail investors could lose tons of money when they opt to invest their money and there are numerous reasons associated to this. Among these reasons are brought by the investor’s incapability or lack of knowledge to manage risk. In the financial world, you’ll hear risk/reward very often. But do you really know what it exactly means?
Investing your money into market comes with certain degree of risk and you must be compensated for taking risks. If someone you trust asked you for a 50 dollar loan for instance and then offered you to pay 60 dollars within 2 weeks, it may not be worth of the risk. However, what if the same person said you’ll be paid 100 dollars within the same period? The risk of losing 50 dollars is overshadowed by the money you can make.
By figures, this is a 2:1 risk/reward. This is a ratio in which most professional and experienced investors would immediately jump over. Likewise if you are offered 150 dollars, then it makes the ratio 3: 1. Now, let us bring the same analogy to the stock market. Assuming that you’ve done your research and discovered a stock that you like. You took notice that company XYZs stock is trading currently at 25 dollars, down from its recent high of 29 dollars.
Risk and Reward in Action
You firmly believe that if you make your purchase now, XYZ will recover back to 29 dollars sooner or later and then, you can cash in. You have 500 bucks to buy stocks and thus, you bought 20 shares. When it reach its 29 dollars share once again, you can cash in and made an automatic 100 dollars profit without hassle.
Another thing to know is that, every person has tolerance risk of their own. You might be someone who loves adventure but somebody else prefers to stay at home and relax. This has to be taken into account as well. Your risk tolerance will be different from others.
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