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The Daily Dose: Questions For Stock Traders

What is Risk Tolerance and Why is it Important to Understand?

By February 22, 2018No Comments

Your Risk Tolerance Dictates How and What You Trade:

Risk Tolerance, also known as “Risk Appetite”, is the degree of volatility or variability that a trader/investor is willing to withstand. Each individual trader’s risk tolerance is critical because it dictates how and what instruments they are willing to utilize. Conservative or “Risk Averse” traders have little or no willingness to accept volatility in their portfolios. Aggressive traders, however, pursue highly volatile instruments in an attempt to capture maximum returns. Overall, your personal risk tolerance can be defined as your ability and willingness to stomach large swings.

Retirees, for example, are often looking for a conservative approach to growing their portfolios. The focus is more on capital preservation as opposed to growth. These individuals have spent decades building up their nest eggs and aren’t willing to lose a large chunk of it at this point in their lives. For that reason, they target safe, steady investment vehicles like Bank CD’s, Money Markets, and US Treasuries. Younger individuals can tend to be more aggressive because they have time on their side. In other words, they have future opportunities to earn more capital to offset any potential losses early on. Aggressive trades/investments can be small cap stocks, penny stocks, speculative biotech stocks, short-term options that can potentially expire worthless, etc. In the end, individuals can pinpoint their risk tolerance by considering factors such as time horizon, availability to monitor positions, personal preferences, and portfolio value, and it’s crucial that each move they make in their portfolio aligns with their appetite for risk.

Related Post: What is Portfolio Allocation?

Matt Thomas

Founder of TradingParadigm.com, Creator of the Trading Success Framework Course & Trading Paradigm Skool Community, and Intraday Futures Trader Using Auction Market Theory & Profiling (Volume & Market Profile).

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