Education 101: The Most Common Trading Question

Risk tolerance comes up in a lot of trading conversations.

And the usual response I give is – well…  how much can you afford to lose?  What’s your personal risk tolerance?  It may seem like a ridiculous question, but it’s also one of the most ignored.  In fact, some traders are so focused on hitting that jackpot trade, they never stop to ask themselves how much they can really afford to lose.

That alone will destroy your portfolio over time.

Once you understand that, you can build a portfolio that actually produces results.  It can also keep you from damaging your potential.

Let’s say you want to risk $10,000 on a “sure thing” that your neighbor told you about.  “It’s the best stock in the world.  You can make a fortune off this.”  Trusting him, you risk $10,000 and watch the stock lose 50% of its value in days.

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However, could you afford to lose $10,000 on a single trade?  If not, why would you risk that amount on a “sure thing” or not?  Cut it in half.  Cut it in quarters.  Cut it in tenths.  In short, be realistic about what you can really afford to lose.  If you have a $100,000 account and you risk 10% of your portfolio on each trade, and each trade is a loser, you just wiped out your account in no time. 

Instead, ask yourself these simple questions.

No. 1 – What can you afford to lose?

How much money do you have available to you to trade?  How much do you need to pay your bills, yet trade comfortably?  How much of that left over amount can you afford to lose?  This is more about whether you have enough assets to handle potential capital loss.

No. 2 – What is your time frame?

When do you plan on retiring?  Think about the time you have remaining until you reach your goals.  In fact, as you approach retirement, your risk tolerance actually decreases.  Always take into account your personal time frame when it comes to risk.

No. 3 – Are you an emotional trader?

We can’t tell you how many people trade on emotion.  Their stock falls 50 cents.  They panic.  They sell.  Then the stock moves back up.  And they curse themselves.  Your emotional ability to deal with risk should be considered always.  You must also understand that your risk tolerance will change over time, as your age, income, and life circumstances change. 

Learn Risk Management from Seasoned Pros. Apply Your Knowledge
and Skills and Get Paid To Trade! Learn How Here