Every deal, trade, investment or business must be undertaken on the basis of a strictly applied limited risk approach. That is, you should only be prepared to lose a fixed and limited amount of money on the investment. You have no control over what the market will do; you have no control over the share price. Strangely, however, one of the few factors completely in your control is how much you are prepared to lose.

Each time money is invested in a share, the risk being assumed by that investment action must be identified before the investment is made. Once the risk amount has been identified, the next decision is to decide on the method of risk control which will be employed as part of the investment plan. Saratoga's Safe Investing Method? uses three alternative risk control methods.

Each investment must also have the potential for profit of several times the risk.

By strictly applying this rule for every investment, the overall profits will end up greater than losses incurred.

You never know whether a share investment (or other investment) will profit when you enter into it. Every investment you undertake must therefore have a risk-to-reward ratio of better than 1 to 2. Then, even if only half of your investments are winners, you must make money. It is good practice to target a minimum of 1 to 3 risk-to-reward ratio.

Managing Money Through Diversification

There needs to be a spread of investments (or trades or deals), in order to ensure an overall profit. If you knew which particular investment or share would provide the best return in the future then you could put all of your money into just that one investment and wait for the return. Unfortunately, no one knows the future, so putting all your eggs in one basket is a very high risk strategy.

Any deal, trade, or investment can completely fail. Occasionally one will. Rarely, a bluechip company will go into bankruptcy. These factors are not known up-front at the time of making the investment. If they were, you would not make that investment.

The safeguard for this contingency is to invest only a small percentage of your wealth in any single investment. This is called diversification. For example, assume you had ten different investments each of equal value, and one of them failed completely, then at worst you have only lost 10% of your wealth. It is probable that you will still make an overall positive return for the year despite this major failure as the other 90% of your wealth continues to work for you.