Friday, 31 May 2013

High Risk High Reward Strategies

Does the idea of a high risk high reward investment strategy excite you or make you scared? It is the general perception amongst most people that in order to make spectacular gains you must take spectacular risks. This is definitely a myth as there are plenty of investment strategies that allow you to make massive profits with very little risk. Today I would like to have a look at some of the emotional and decision making processes that take place when using high risk high reward investment strategies. Am I saying that high risk investment strategies are bad? No definitely not, high risk strategies have a time and place but they must be one of many strategies that you use - not your main investment strategy. I would also like to mention that there are plenty of ways to make high rewards without necessarily taking high risks. If your broker suggested that you have a look at a particular trade that required $1000 that would double to $2000 if it was successful or you would loose half ($500) if it was unsuccessful - what would you do? In my experience most people are pretty happy to accept the challenge and take a small risk for the prospect of a very good profit. Would your decision change if your broker offered you the same trade but instead of $1000 you had to put $100,000 o the line. So if successful your profit would be $100,000 or your loss would be $50,000. Suddenly most people aren't too keen to take on the trade - Even thought the odds are EXACTLY the same. Obviously the prospect of losing $500 is much less frightening than losing $50,000 but I believe that it shouldn't make any difference to your decision making process. A high risk high reward investment strategy is exactly that - an investment strategy that that has the potential to loose or win you a lot of money. I prefer to look at all investment strategies as a percentage rather than in dollar terms. This has two main benefits that are vital to developing a strong mindset that is vital when trading (especially if you are using high risk high reward strategies). 1. It makes you look at the trade in relation to the actual value of the trade. The above example is the exact reason why this is beneficial. Should you place a trade that has the ability gain a profit of $100,000 or a loss of $50,000? There is no right or wrong answer but if you start looking at the percentages of the trade you will be able to make a much clearer decision. Always make sure the numbers stack up no matter how big or small the trade is and especially when you are using high risk high reward investment strategies. 2. The best thing about looking at your trades in terms of a percentage is that it stops you from getting to emotionally attached to the profits and losses that you will inevitable have. For instance if you were to make a $5,000 profit on one particular trade it is very easy to start getting ahead of yourself and spending the money on flights around the world, cars, boats etc. If you keep focused on the Percentages you can be extremely happy with your trade but not get to over the top. Using percentages is even more important when you have a loss on the stock market. When you lose money is very easy to start thinking about how many hours of 'normal' work you have just lost and very quickly you are so depressed that you never want to trade again. It is quite common for new traders to want to quit after their first loss on the market - even if they have still made a profit over all! Using percentages gets you away from this mindset and makes you analyze your profits and gains in a much less emotional state. So does this mean that high risk high reward investment strategies are a thing of the past? No, it just means that you should really think about the pro's and con's of every investment that you make. One of the main reason why people love using high risk high rewards investment strategies is because they love the feeling of taking risks. You only need to go to the casino to see that many people are addicted to the rush of gambling with their money. The question you need to ask yourself when you are placing a trade is - are you Gambling or are you Trading?