No one likes to lose money. That’s human nature. But people have a wide range of risk tolerances. If you’ve been mulling over how much riskiness you can stand as a trader, maybe it’s time to examine a few techniques for adding a dose of caution to your methods. What is trading risk, and how can you minimize it? The answer to the first part is easy. Trading risk is the statistical probability that a given investment might generate a loss. That loss can be of any size, from tiny to total. In the case of some kinds of securities, it’s even possible to lose more money than you invested.
How to keep trading risk at a bare minimum? There are several ways that can work together to keep your own level of trading risk rather low. Realize that you can never eliminate risk in a free market. The key to the dilemma is understanding the various techniques and then deciding which ones are best suited to your particular style of trading. Here are some strategies that have worked for others. Many are very old while a few a relatively new.
Dollar-cost-averaging, DCA, is a straightforward, simple way to buy securities of all kinds. If, for instance, you want to invest in the precious metals markets but feel that prices rise and fall mostly at random, you might employ DCA like this: If your budget allows $1,000 of trading capital per month, you’d simply purchase that amount of your favorite metal, say it’s gold, every month on a specific date. At the end of the year, you will have virtually eliminated the volatility factor from your purchases by using DCA. In the early part of the last century, many working people used this strategy to purchase fixed dollar-amounts of blue-chip stocks every month, quarter, or year. Sometimes you’ll hear DCA called the constant-dollar plan.
There are dozens of ways to use put and call options to lower the inherent risks of buying and selling securities. For example, if you purchase 100 shares of a stock at $20 per share and expect it to rise in value, you could mitigate the riskiness of the transaction simply by buying a put option for a small fee. Then, if the price declines rather than rises, you’d be able to exercise that put-option and sell the security at a designated price. You might not make a profit on these types of trades, but using options as a sort of price-decline insurance, you can sometimes cut losses significantly. Fortunately, there are plenty of great online resources that offer a list of options trading strategies used by stock, bond, commodities, forex, and precious metals traders.
Don’t Sell During Downturns
When the going gets tough, smart investors don’t sell their holdings. Taking the long-term view of the securities markets as an always-rising entity, you can avoid the risk of taking huge losses by simply holding onto your assets when the exchanges experience major dips. If you want to verify this strategy for yourself, simply look at the last three major economic downturns, those in which the stock market took a hard hit. Eventually, prices returned to normal. Of course, sometimes it can take several years for price levels to bounce back. The thing to remember is that prices usually reach their pre-crisis zone, so if you are willing to stick it out, you can avoid those giant losses.
Buy Index Funds
Buying index funds is a simple way to avoid a lot of the inherent volatility of the securities markets. Not only can you avoid a lot of risk, but you can have fun doing it. There are index funds for every taste and in virtually every sector of the market. Whether your tastes run to the Dow Jones Industrials, the S&P, or international indices like the German DAX, you can find a less volatile way to invest your money by using these funds. Many investors never buy anything but index fund shares and enjoy quite a bit more peace of mind than most get from the securities markets.
Use Capitalization as a Guide
Some investors only purchase shares in companies that have high capitalization rates. Typically, those are blue-chip type corporations that have issued shares that are currently valued higher than average. Companies like these are often sought out by long-term investors who want stability rather than the chance to make a short-term profit. If you want to dampen down the overall risk level in your portfolio, consider including these high-cap stocks.