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Your personal investment strategy is the investment plan you design to reach a goal. One of the most crucial factors in your investment strategy’s success is your risk/reward ratio.
Calculating Your Risk/Reward Ratio
Personal investors should calculate the risk/reward ratio for every trade or transaction. Do so by:
- setting stop and limit orders – Automatically sell stock should it rise or fall to certain thresholds. This will allow you to see the best and worst outcomes possible in a trade at the outset, and it also allows you to avoid a devastating loss.
- determining potential profit and loss – Divide the maximum potential profit by the maximum potential loss according to your stop and limit orders. This should result in a risk:reward ratio.
Every personal investment strategy is unique, depending on how large your goals are and how quickly you want to reach those goals. However, there are a couple of general tips:
- going 1:2 – Although those willing to take more risk for more potential profit may deal with risk/reward ratios that are higher, a 1:2 risk:reward ratio still guarantees the likelihood of profit without a great chance of loss.
- open one trade at a time – More seasoned investors can juggle multiple trades in a personal investment strategy at once, but a safer way to insure a favorable risk/reward ratio is to deal with one open trade at a time, so you can watch it closely and sell when necessary.
