Why Risk vs Reward Is Crucial To Your Trading Success

October 25, 2021

Investing is often a fantastic decision to make. None more so than now in a time where savings rates at banks are paltry as the Bank of England’s interest rate is at historic lows. So, with inflation starting to rear its ugly head again, investing can offer a means to make returns that are worth talking about, but also that beats inflation allowing investors to retain their purchasing power. 

However, investing is a risk. There is the chance that when you buy a stock, that those stocks could lose value. In fact, there is always a chance that you will not recoup any of the original value of your investment at all. Companies do go bust. It is not an every day occurrence, but it definitely does happen. 

For that reason, investors do their best to circumnavigate this risk in a variety of ways. Portfolio diversification is one such strategy, but investing in companies that are calculated as offering the most reward for the least amount of risk is also a much trodden investment path. 

Here, we delve into the idea of risk vs reward a little deeper. Doing so can help you choose the best stock trading platform UK for you or the best brokerage accounts. For, how you seek your reward, balanced against the risk you are willing to take, will have a fundamental bearing on where and how you invest in future. 

What is a Risk Profile? 

A risk profile is essential to get in place before you start trading or investing. Doing so will ensure that you only ever invest what you can afford to lose and will prevent you in investing in totally unsuitable investments for your circumstances. 

Risk profiles depend on a number of factors. Your age is just one of the factors that needs to be taken into account when working out your risk profile. The main idea behind age and investing is that the younger you are, the more risk you can afford to take as you have longer to recoup any losses that you may unfortunately make. However, of course, when you are younger you do also tend to have less money. So the amount of money or cash you have saved in your bank is also a factor to bear in mind when calculating your risk profile. The ideas of age and amount of funds helps determine a person’s ability to take on risk. 

However, in conjunction with a person’s ability to take on risk is their willingness to take on risk. Some people - even very young people of great personal wealth - may be very risk-averse and prefer to invest their money in low-risk assets like bonds. Some people, despite having very little to lose, will be happier taking on a risky investment. 

What is Risk vs Reward? 

The idea of risk vs reward is fundamental to almost all investment strategies therefore. No sensible investor will invest in a riskier investment, if they can be guaranteed the same reward with a less risky company. 

Risk vs reward is also a ratio that can be calculated to help make informed investment decisions. A risk reward ratio is calculated by determining how much you are willing to lose before exiting a position. Or, to lut it simply, at what price you cut your losses. That amount is then compared to at what point you want to take profits. So, say you buy stock A for £20. You decide that if that stock devalues to £15, you will want to exit that position, losing £5. However, if that stock goes up by £10 to £30, that is also when you want to sell to take profits. The risk reward ratio 5:10 or 1:2. That then means that you have entered into a position where the reward is twice as big as the risk. 

By exiting positions according to risk reward ratios, you may eventually limit your profits, but importantly you limit your downside risk too. 

Recommended Read: What is Financial Freedom and 5 ways You Can Get There

Where is The Best Platform to Invest?

If you want to invest using this risk reward strategy, finding the best cryptocurrency brokerage firm or the best trading platform for you is down to finding a platform that allows you to put what is known as stop loss trades on as well as profit targets. A stop loss trade is an automated trade that means your platform or broker will sell your shares in a company if it has reached a level that you do not want to go below. The same is said if a share reached a price you want to take profit at. 

Of course, there are other factors that you will need to consider too when signing up for any investment platform or brokerage. The minimum deposit required is crucial to get clear straight from the start as that may preclude you from setting up an account with an investment platform in the first place. 

But other issues such as fees are important to investigate too as how fees are structured can also eat away at any profits that you make with your risk reward strategy. Finally, look into a trading platform’s asset class selection. You may want to invest in several assets at a time. Doing so will help you diversify your portfolio. However, not all investment platforms have a wide range of asset classes, so be sure that any long term plans you have to have a multi-asset portfolio are not hampered by your chosen platform. 

Investing According to Risk vs Reward

Investing according to how much reward can be made, in spite of some risk, is perhaps at the crux at every investment. While some risk can, to a certain extent, be mitigated against, not all risk can be diversified away and eradicated. All investments carry some risks with them. But investments can carry the potential for a great deal of reward too. It is down to investors to identify the investments that have the greatest potential reward with the smallest amount of risk. And, when that risk has been identified, to decide how much money they are willing to lose before cutting their losses and investing elsewhere.

Rachel Lee
Having worked at Morgan Stanley and BNYMellon for over 10 years in pensions and investments, Rachel now works as a full-time business and financial writer.

Risk Disclosure: Trading in financial instruments involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Before deciding to trade in financial instruments you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed. Best10Stockbrokers would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Best10Stockbrokers and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Best10Stockbrokers and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website. Best10Stockbrokers may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.

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