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One very important aspect to protecting our investment
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Risk management? - How/why so?
When investing or trading in the share market, it is important to be aware of the risks involved, and to mitigate the risks where possible, and minimise any possible impacts of adverse events. With appropriate risk and money management, the share market is not as scary, nor as frightening, as some people might believe it to be, and we can “sleep at night”.
One way to tackle this is to look at all the things that could possibly go wrong, and then work backwards to consider how to mitigate these events - that is, perform a risk analysis to identify the risks, and then consider the strategies to mitigate the risks. We won't actually do that on this web page, but the following discussion addresses the mitigation aspects. A discussion on Risk Management with a risk analysis is included in Brainy's free eBook Article ST-4000, "Risk Management" (see More information links at right).
Money can slip away - brokerage, commissions, slippage
There are three things that can easily eat into profits:
Depending on the size of trades, and the time for which the position is held, these items can eat away at the investment capital. Of course, larger position sizes can reduce the impact of brokerage fees and slippage. Assuming a brokerage fee of $20 per trade, it can be demonstrated that a parcel size of at least $1500 will help to mitigate these costs. And the impact of slippage can be mitigated by trading in heavily traded stocks - that is, avoid the thinly traded or less liquid stocks.
We will be wrong
One very important thing to understand is that it is not possible to be 100 percent correct with our investment decisions. This is difficult for some people to come to terms with - especially those who are professionally trained in some fields such as engineering, mathematics or science. You see, the field of Technical Analysis is not an exact science - there is an amount of "art" involved, and trading the markets based on technical analysis is actually playing on the likelihood of the future price activity.
Some studies from some of the profitable experts conclude that a win rate of only 40 percent can still result in profitable outcomes. Provided we cut our losses quickly - to minimise the losses, and let our profits run. Provided we have wins that are larger than our losses, then the Win to Loss Ratio of 4 to 6 can still be achieved.
By giving careful consideration to your own stock universe, you can eliminate so-called higher-risk stocks from your portfolio. Just some of the considerations include:
There are several stock universe considerations - read more about them here.
Good money management
There are a number of strategies that can be employed to manage the investment capital in a sensible manner, including:
Many investors still persist with the long-term buy-and-hold approach for share market investing. However, there are more and more investors who can see that in today's market conditions, such an approach is no longer the best one. Many investors are comfortable with selling some shares in order to protect their capital. But on what basis do they decide to sell? This is not straight forward, but they carefully pull together an Exit Strategy, which might be a simple Stop Loss approach. Read more about Exit Strategies...
A good Exit Strategy is very important in case the investment starts to go against us, so that we might cash in the position before too much is lost. One particular, and rather simple Exit Strategy, with share market investments is the humble Stop Loss - where we might determine a share price value before we enter the position, and if the share price falls to that level then we sell without question. This removes the emotion from the situation, and removes any discretionary aspect. See more about Stop Loss...
Gauge the mood of the market
Now this is not an easy topic to get one's head around. But let it be said that if one has a feeling for the overall mood of "the market", then one won't be surprised when the market behaves in a particular way.
For instance - in early 2008 many technical analysts were not surprised when the world's markets crashed and suffered a bear market. By being aware of the overall market mood, these analysts were able to confidently implement capital protection strategies. Don't forget that a market correction, or bear market, comes around about every 4 years. Don't believe it? See more details...
There are many ways to gauge the mood of the market. Just one method in the charts is to watch for bearish divergence. See more details about divergence (bearish and bullish)...
For more information on these topics, refer to the web links above, and the references in the top of the right hand column.
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