Risk/Reward – Important Component Of Investment


Investment is a risk, yet it is more risky not to take risk especially in Investment. Because of the risk attached to Investment, the successful ones learns the implication of the risk to be taken, then they play around the dread of incurring losses and that is why they become rich in the long run.

What do the Successful Investors Do?

Foremost successful Investor look for the risk region before looking for reward/profit but those who make losses look first to reward and are blinded to risk. Where there is profit, there must be risk beside it. Without knowledge of inherent risk, profit-making becomes a gambling or illusive venture.

The role of experience and adequate education all help to reduce risk but they do not eliminate risk – and without the understanding of the risk/reward level of a given Investment, you may be in for trouble.

Some of the questions to ask include

• What is the nature of the risk involved?

• How volatile is the market?

• Who controls the force of the market?

• Do I have what it takes to manage the risk?

In this section we are more particular about quantifying your risk/reward ratio before stepping into Investment – that is taking calculated risk. In all Investments the input/output ratio should be less than one, this means that input should be less than output: in other words there should be profit after all expenses – i.e. the risk should be less in quantity or probability than the profit at the end of the day.

• Risk Gauged on Probability: If you have a risk of say $500 but with probability of loss at say 1 out of ten. Then you have a good chance if the profitable trades could average a return of $100 and above.

• Risk Gauged on Quantity: If you have a risk of say $100 and reward on every trade as averaged $150, if you can make one trade for one loss trade i.e. 1:1 then you stand a chance to make profit overtime.

If the chances of a profit is slim do not venture, leave such enterprise to the average Investors if you don’t want to be the average investor out there on the street. Think of it the average investors are wiped.

Types of Risk

Risk Reward ratio differs from Investment to Investment.

• But the general implication is that high yielding Investments are usually more risky than the low risky Investments.

• Another area of risk/reward implication is to learn about the asset/liability factor of a given venture – ability to differentiate between an asset and a liability. For instance, in real estate, investing in apartment could be a liability on the long run if it keep taking money from you as maintenance or tax charges; while investment in a rental outfit like office apartment has an asset that bring in money.

• Another factor to consider in understanding the risk level of a venture is to find out how early someone joins a trend. In the financial world, the time you join the trend makes a difference on your risk/reward calculation – joining a trend earlier signifies potential profit for you.

The rule of thumb when drawing a logical risk/reward ratio is as follows:

For extremely risky Investment though profitable e.g. foreign exchange market, the savvy investor do employ a minimum of 1:4 risk/reward ratio coupled to their experience of the market. This means that a risk (stop-loss) of $30, you should stand a chance of earning in return $120. But for the extremely low risk and stable Investments where capital investment is in its most stable e.g government bond, the risk/reward ratio is reverse i.e. 1:4 meaning that for a risk of invested $80, you stand to earn say $20. In this case you hardly lose, therefore your $80 is highly favored to earn another $20.

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