What are your Investing Risks?
It can be a risky business investing in the stock market. There is risk. And all you can do about it is accept that there are some risks that you have control over and some that you can only try to prevent.
The key is to have pre-set risk levels and a management plan in place. When you make thoughtful investment selections that meet your goals you are usually keeping your stock risks at an acceptable level. This is because you are consider risk when making decisions.
However, you have to be aware that there are inherent risks that you cannot control. Most of these risks result in investors having to simply ride out the storm. For the long term investor, many risks are downplayed by the time factor.
There are four major risks that investors face when investing in stocks.
Risk #1: The economy
The most pressing risk of investing in the stock market is that the economy can always take a downturn. A combination of factors can cause the market indexes to lose significant percentages. In fact, we are just now returning to the levels of the pre-September 11 market.
In general, the economy is just going to happen. There is nothing you can do to control it. Most young investors are best off if they just ride out the downturns. Investing for the long run really helps. In fact, many investors use the downturns to pick up stocks that are good solid companies at a slightly lower price.
If you are an older investor, a major downturn of stocks can be devastating if you haven’t moved the significant portion of your portfolio from the stock market and into bonds or fixed-income securities. This is where management and risk tolerance really comes into play. Don’t put things off. You never know about the economy.
Risk #2: Inflation
Inflation will always be a risk to investors. It hits everyone, no matter their savings or portfolio size. It will destroy the value of your dollar. It is the cause of recessions. We like to believe that we can control inflation, but sometimes the cure is just as bad as the problem. Higher interest rates can help to mitigate inflation, but they can also hit the market in a negative way.
Investors usually retreat to hard assets, such as real estate, when inflation gets high. But in most cases, stocks are usually a pretty fair protection against inflation. the idea is that companies have the ability to adjust prices to the rate of inflation. There are some industries and sectors that adjust more than others, so you should diversify your investments. Investors are hurt by inflation by the erosion of the value of the dollar. Those on a fixed income will suffer the most. That is why it is a good idea to keep a portion of your assets in stocks, even when retired.
Risk #3: Market Value
Market value risk occurs when the market turns against your investment, or even ignores your investment. For example, the market often chases the next hot stock, leaving many good companies behind. Some investors will use this to their advantage — buying stocks before the market realizes their potential.
However, it can also cause your investment to flat-line while other stocks rise.
Diversification between different sectors of the economy is key. When you spread out your investments, you have a better chance in participating in growth.
Risk #4: Becoming too conservative
There is nothing wrong with being careful. However, you can go too far in how conservative you are. If you never take any risks, it is probably that you will not reach your investment goals. You know that investing in a savings account for the next 20 years isn’t going to give you enough of a return to retire. You have to be willing to accept some risk. Just keep it under a close eye.
When you know the risks of investing and research your stock potentials, you make decisions that help you not only mitigate risk, but eliminate a large portion of stress as well.
Martin Lukac
http://www.articlesbase.com/investing-articles/what-are-your-investing-risks-90867.html
Filed under: Stock Investing
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What are some ways to lower risk, when your investing?
Bonds, Mutual Funds, ETF’s and Diversification all lowers risk of investing is their any others?
Diversification is first and foremost: stocks, bonds, commodities, cash, etc.
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Diversify by asset, region, and sector.
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10 years industry
Bonds
Mutual Funds
Cash
PPF
Infrastructure Bonds
Treasury securities
Commodities like Gold
Real Estate Investment
EPF
Cheers,
http://www.buzzingstocktips.com
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Yes! For stocks and ETF’s here are some suggestions:
1. Position sizing is one way. That’s when you decide the maximum amount of money you will place in any one position. That will automatically diversify your money and limit risk to your overall portfolio.
2. Predetermining how much you’re willing to lose in any one position before you buy a stock and setting a stop loss at that level to protect the majority of your capital.
3. You can look at a stock’s ATR or average true range to get a sense of how volatile a stock is before buying it. ATR tells how much a stock’s price will range in a day. For example, if two stocks are priced at $10 and one has an ATR of $1 and the other is .50, then the stock with an ATR of $1 has a daily volatility (range) risk of 10% versus the second stock at 5%. Purchasing the stock with the lower ATR will decrease risk level.
You can look at any stock’s ATR in a chart program or should be available on charts your broker offers. It’s just a separate indicator that you can look at with the chart. You can also use the ATR to pick a stop loss point – say 2 or more times the actual ATR figure.
Those are the main ways to adjust risk level and they’re well worth employing.
References :
http://www.stock-trading-warrior.com/Money-Management.html
Everyone here, except the Warrior, talks of diversification.
The time to diversify into bonds is certainly not at the bottom of an interest rate cycle. You would be diversifying into increased risk, not less. You have to be careful talking about diversification at the end of cycles.
Diversification in general is too broad a topic to debate here, but if you’re already invested in stocks, taking part of your money and investing in a mutual fund (which invests in stocks full-time), would NOT be a form of diversification, except to increase risk, rather than decrease it. At least you can sell your personal holdings, but a mutual fund is always invested. You can use a stop loss order where a mutual fund cannot. A fund invested in hundreds of stocks is not necessarily more diversified than the 12 stocks you already own; not if diversification means lowering risk.
True diversification would be to invest in something completely uncorrelated to stocks, like oil or gold or maybe currencies or a hedge fund or commodity fund that invests in these. It’s all well and good to talk about investing in these things, but not many people actually follow through and do it without going through a fund, even though it is much easier now through ETF’s like GLD or OIL. But few people think they know enough about it to actually do it.
At certain times — even with these latter methods, you are not diversified at all, like during 2008 when everything fell in price together. There were no safe havens — gold, oil, bonds, stocks — everything fell in price. If you can recognize that prices are falling in everything together, that your stocks are getting stopped out left and right, then you let the market tell you when to diversify into cash. If prices are falling day after day and you recognized this increased risk, a way to diversify would be to short stocks or ETF’s.
Once again, if you are able to recognize where we are in the economic cycle, then there are additional ways to reduce risk. This goes against the Buy & Hold theory of the average investor or college professor, but you cannot persuade me that the risk was the same in gold at $400/oz as it is now at $1,240/oz. You cannot persuade me that the risk was the same for stocks in 1992 at a level of 3,000 on the Dow as at the end of the dot.com bubble in 2000 when the Dow reached 11,000.
Any time the Dow extends too far in one direction, whether up or down, risk is increasing of a reversal, and you should be looking for signs of that reversal to take advantage of either protecting your profits or profiting from getting in at the most opportune time for high rewards.
Now we have a new concept — risk/reward ratio. Risk evaluation can help to tell you when to be out. Risk/reward evaluation can help to tell you when to be "in."
You’re on the right track. But conventional risk evaluation from the Buy&Hold crowd won’t help you much. They can’t define risk except in general terms which are completely useless.
To answer your question, you have to define risk specifically, to a set dollar amount, before you can do anything at all about it. Investors leave risk up to Hope (Buy& Hope). They have only a general description of risk, not a definition.
A trader has complete control of his own risk. If you chase price and buy on an extended move in price, your risk is great. If you buy on a pullback in an uptrend, your risk is smaller. This is true whether your time frame is years, months or days. Where you set your stop loss defines your risk exactly, precisely, emphatically, beyond a shadow of a doubt, and no amount of hope is going to change your risk, so hope becomes a worthless idea and you can do away with it. Set your stop and you can stop worrying about it, because worrying will not change the outcome, then the market can tell you what must be done, rather than you trying to tell the market what to do. Plus you will sleep better knowing you are protected at least somewhat.
So we come to the final way to lower risk in a high-risk environment. It is simply to follow the trend. Buy in an Uptrend and sell or sell short when the trend changes. Unfortunately, most people will spend more time choosing the color of their new car than on reading a good book on developing a trading plan.
Sometimes cash is King. There are no guarantees. Nothing is perfect. The future is always uncertain. That’s why we develop a plan ahead of time. As part of that plan, another way to reduce risk is to use good money management techniques for when we’re wrong, and let our winners run when we’re right, and maybe add to our winners and trail the stop..
Thank you for your excellent question. Few people understand that risk is their first problem, and spend the rest of their lives worrying and hoping what’s in the uncertain future. Few realize that to manage risk is to choose to take responsibility for their own financial future.
Addendum
Even an advanced or learned investor like Guapo with a Masters in Finance just doesn’t get it. They are merely parroting what they learned in Econ 101, that risk/reward is a linear relationship — "for increasing return, there is a corresponding increase in risk." Hogwash, this is just a theory, like Evolution, but taught as fact, when it doesn’t hold water.
If you buy stocks in the beginning of the economic cycle, soon after a Downtrend is broken, the risk is much less than if you buy the same stock a few weeks or months later at the end of the economic cycle, proving that risk is variable, not a constant. There are many similar ways to do the same thing, show the same thing, and reduce risk, but I do not give away gems for free to the undeserved. Nonetheless, the Econ 101 risk/reward chart is debunked, because stocks cannot be in two different places on the X axis of the graph. Guapo and his Masters degree and 20 yrs experience is proven useless, and so is Buy & Hold theory and nearly every other fund manager and adviser out there. Diversification is only another form of picking your investment from the Econ 101 chart and pales in comparison to any true evaluation of risk. Only you can reduce risk, because 99% of the people out there don’t have a clue .
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To lower your risk, simply increase your percentage of "safe" investments (such as cash/money market/CD’s, and short-term/high-quality and/or government bonds). Note, however, that the "safer" the investment, the lower your expected long-term return. CD’s, for example, are now only paying around 1% – 1.5%.
I hope that helps. Good luck!
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Former stock broker, MBA in Finance, and 20+ years investing experience
A share trader would be able to showcase some best advise on this like Mansukh or Sharekhan etc..
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