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Module 8: Lesson 3

  1. Decide on a risk-to-reward ratio.

Work out how much risk you’re willing to take on before you start trading, both for individual trades and for your overall trading strategy. It is highly critical to establish a risk limit. Market prices fluctuate constantly, and even the safest financial instruments are not without risk.

Some very new traders prefer to take a lower risk to get their feet wet, while others out there prefer to take a higher risk in the hopes of making bigger profits – the choice is entirely yours.

It is possible to consistently profit even if you lose more often than you win. It all boils down to a question of risk vs. reward. Traders prefer a risk-reward ratio of 1:3 or higher, which means that the potential profit on a trade is at least double that of the potential loss. Calculate the risk-reward ratio by weighing the amount you’re willing to risk against the potential gain. The risk-reward ratio is 1:4 if you’re risking $100 on a trade with a potential gain of $400.

Keep in mind that stop-losses can help you manage your risk to a very large extent.

  1. Determine how much money you have to trade with.

Consider how much money you have available to invest in trading. Never take on more risk than you can afford to lose. Trading entails a high level of risk, and you may lose all of your trading capital (or more, if you are a professional trader). Before you begin, do the arithmetic to ensure you can afford the greatest possible loss on each transaction. If you do not have enough trading cash to get started right away, use a demo account to practice until you do.