I frequently say, "Buy companies, not markets," and I firmly believe that you can achieve success by purchasing high quality firms and making investments without giving the state of the stock market any consideration. Market forecasting is a fool's game, and the strategy will appeal to your emotions. Never forget that bad news sells; at the present, every commentator is overflowing with it. When the audience's opinions and choices are virtually universal and congruent, it can be quite difficult to think differently. When everything seems to be pointing in one direction, consider the opposite. Predicting larger markets will also knock you off your feet. Since you are a stock picker, you shouldn't base your decisions on the direction of the market.
The stock market was set up to fool you, not to make you money. Start with this statement every time you analyze an investment, it will help enormously with discounting the emotional element that can so often be attributed to losses.
Value investing is practically alone among techniques that provide you exposure to the upside with minimal downside risk, so in a bear market that discipline becomes very crucial.
So, let’s say you have your quality portfolio of solid names. A rising tide lifts all boats, and the opposite is true too. The stock market in general has had a good run, it is having a wobble which may or may not result in a larger fall. You should always be thinking about the risks. Evaluation of risk will take your mind away from P&L, because as you might have experienced in the past, stocks may bounce and enduring a P&L short term loss is fine if the risk aspect of the investment hasn’t changed. Liquidation on a P&L move is what really bites you. The return of volatility is inevitable and some of your investments will ultimately be lost or be underwater at some stage. No one likes to lose money in the stock market, but it's an inherent risk. Knowing how to manage these losses can make a significant difference. Here are 5 pointers to minimize losses.
- Understand Your Risk Tolerance – One of the most important things to do. Assessing your capacity and willingness to put up with volatility and probable losses in your investment portfolio is the process of determining your risk tolerance in the stock market. Your investment plan should be influenced by your risk tolerance, which determines the kind of assets you are comfortable owning and the amount of risk you are willing to take to potentially increase your returns.
- Financial Capacity: Are you able to accept risk? To find out how much money you can risk without significantly lowering your level of living, evaluate your financial condition.
- Longer investing horizons typically allow for increased risk taking because you have more time to recover from market downturns.
- Emotional Tolerance: While some people can handle a lot of instability, others cannot. You must be honest about your capacity to withstand temporary setbacks and whatever stress they may cause.
- Knowledge and Experience: Having knowledge or experience in investing often enhances your risk tolerance because you are more knowledgeable about market behavior and risk-reduction techniques.
- Financial Objectives: Your risk appetite should be in line with your financial goals. Saving, as an illustration
- Diversify Your Portfolio - In the stock market, diversification is the process of spreading your investments over a variety of assets or asset classes to lower risk. The core tenet of diversification is that several assets frequently react to the same economic event in different ways. So, when one or more individual assets do poorly, you're less likely to suffer big losses by maintaining a diverse portfolio. For instance, if you put all your money into a single stock or industry, you run a great chance of losing it all because the success of your investments depends entirely on the performance of that stock or industry. Your portfolio will probably see significant losses if that specific stock or industry experiences a slump.
- Use Stop-Loss Orders - In the stock market, a stop-loss order is a form of trading instruction that instantly sells a security when its price reaches a specific threshold. A stop-loss order's main objective is to reduce an investor's possible investment losses. If a stock you hold is now trading at $50 per share, as an illustration, you might set a stop-loss order at $45. The stop-loss order would automatically trigger a sale if the stock's price dropped to $45 or less, therefore minimizing your loss. Although the idea of a stop-loss seems straightforward, it can be challenging to use efficiently for several reasons:
- False Triggers: A stop-loss order may be activated by recent volatility, prompting the investor to sell even if the asset's price immediately rebounds. If a position is "stopped out" and the stock thereafter rises, you will have effectively taken a loss that could have been avoided.
- Gaps in Trading: The order will be executed at the next available price, which may be much lower than intended, if the stock opens significantly lower than the stop-loss price owing to overnight news or other circumstances. "Slippage" is the term for this phenomenon.
- Emotional factors: Some investors have difficulty determining the appropriate stop-loss levels. Setting it too far from the current price would negate the goal of avoiding losses while setting it too close to the current price might cause premature selling.
- Costs: Regularly activating stop-loss orders can increase transaction costs and, in some tax jurisdictions, have tax repercussions.
Stop-loss orders do not ensure that you will close a position at the exact level you specify. Your order might not even be filled if it's a "stop-limit" order that sets the lowest price you're ready to accept in a volatile market. Using stop-loss orders can occasionally overcomplicate an investment plan, necessitating ongoing monitoring and adjustment, particularly in erratic markets. The appearance of a stop-loss can deceive some investors into taking on riskier positions than they otherwise would. A stop-loss is not a flawless safety net, though, because of the issues.
- Risk Rebalancing - Market movements may cause your initial asset allocation to become unbalanced, affecting your portfolio's risk profile. Rebalancing on a regular basis—selling outperforming assets and purchasing underperforming ones to get back to your original allocation—can help you keep your risk level at the level you choose. For example, if you initially aimed for a mix of 60% stocks and 40% bonds but stock gains have shifted the balance to 70% stocks and 30% bonds, you would sell some stocks and buy more bonds to return to the 60/40 ratio. This keeps your portfolio aligned with your original risk tolerance and investment goals.
- Risk Hedging - To protect your portfolio against possible losses, use financial products like options. For instance, purchasing put options on equities you already own can act as insurance, enabling you to sell the stocks at a certain price even if the market price decreases significantly. Hedging is typically only advised for more seasoned investors since it can be complicated and expensive.
It is essential to begin stock market portfolio management with a focus on risk since it lays the groundwork for your investing strategy and determines the types of assets you include and how you allocate them. Your investment strategy will be in line with your financial objectives and emotional comfort level if you have a clear understanding of your risk tolerance—your capacity and desire to bear market volatility and potential losses. Ignoring risk can result in poor investment decisions, such as investing all your funds in high-volatility equities when you should be risk-averse, which could cause you to suffer a substantial financial loss and significant mental strain. The key to long-term investment success is to estimate risk up front so that you may better build your portfolio to offer the maximum returns for a level of risk that you are comfortable with.
On the date of publication, Jim Osman did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
