Before putting your money to work, it’s essential to ask these four fundamental questions to make sure your investment is safe and in the best strategic position to accrue value over time.
What is Your Investment Objective?
Too often, people ignore this seemingly bland question or answer as vaguely as – to make money. However, what you are trying to accomplish will determine how often you trade, how much per trade you should expect to lose or gain, what your timeline is for every position taken, and, consequently, what asset you should be investing in. For instance, if your investment objective is to make enough money on a single position to pay for this next month’s rent, then you’ll likely trade a highly volatile asset with a relatively high average price range. This also means you’ll be looking to risk more to increase your potential profits.
How Much Are You Comfortable Losing?
If the money you invest is supposed to pay for next month’s rent, you should think twice about putting it in higher-risk assets. As a general rule of thumb, you should be prepared to lose all of the money that you trade. Any investment venture involves a degree of risk that is unavoidable and can only be lowered. Your answer to this question will determine your stop loss for each trade and the position size you buy.
How Are You Planning to Mitigate Risk?
Perhaps the most crucial question of all involves risk management. As mentioned earlier, no one can avoid losses on every position they assume in the market. The only thing you can do is lower the risk by using proper position sizing, automated stop losses, favorable risk-reward ratios, and so on.
How Long Do You Intend to Keep the Trade Open?
Establishing a time frame for every position assumed in the market is vital to the efficient use of your capital and limiting its exposure to volatile conditions. Determine if the position is a short-term or long-term bet and adjust your position size and stop-loss accordingly.
Answers to these questions will ultimately form your trading strategy. Take the time to answer them truthfully and precisely.