Investment Advice: Managing
Risk’s Key Given the Volatility
Friday, August 12th, 2011
By George Leong, B.Comm. for Profit Confidential
The overall stock market bias continues to be bearish. The selling capitulation remains in effect. Just take a look at what happened on Wednesday:
- DOW down over 500 points
- S&P 500 down over 100 points
- NASDAQ down over 50 points
The fact that we have yet to see a firm bottom makes the situation dangerous.
The key indices are in correction territory. The small-cap Russell 2000 is in a bear market, down 24% from its high and 16.24% this year.
The near-term technical view is BEARISH, as the key indices trade well below their respective 50-day and 20-day moving averages on weak Relative Strength.
The downside risk is extremely high and bearish.
My investment advice is not to go out and dump all of your stocks. Take a step back and think about the situation and where you are with your investments and personal finances.
You may want to take some profits on some of your bigger winners.
The key to successful stock picking is to understand the concept of risk management as an essential element to investing success. The reason why I want to discuss risk management is my sense that there are some of you who probably fail to incorporate some sort of risk-management strategy. If you do, that’s fantastic and you are probably sleeping well at night. If you have been delinquent in this area, be careful.
I have been involved in the markets for over 20 years. After reading the strategies of some of the world’s best traders, a commonality surfaces: the most important tenet in trading is preserving your investable capital via the use of risk management. The last thing you want to happen to you is to trade sloppily and lose your tradable capital. Instead of being a player in the exciting world of trading, you would be relegated to watching from the sidelines. But guess what? You can avoid this by following some simple strategies.
When the price of a stock trends higher, you should always think about a potential exit strategy. Have you done this during the current stock crisis?
This does not mean liquidating profitable trades; but rather protecting your unrealized gains.
If you have a price target for your stock, you can sell the stock when it reaches that target. Alternatively, if the gains are significant, you can take profits on a portion of the position and let the remaining portion ride. For instance, if a stock rises by 100%, you can liquidate 50% of the position and let the remaining half ride. Under this simple strategy, you realize some profits, but at the same time create a zero cost trade, as you have already recouped your initial investment. You can view the remaining half as your risk capital.
Another strategy that needs to be considered is the use of mental or physical stop-loss limits. The reality is that no one is perfect in trading. I have made mistakes and so have many of you. If you can accept this, then that’s half of the battle. The problem is that during a fast market such as we have now, setting a stop too close will likely take you out prematurely. So, at times of market chaos, you may want to make the stop price lower. The last thing you want is to be stopped out during a big down day and then watch stocks surge like last Tuesday. Conversely, setting the stop too low can entail large losses.
And, for those of you familiar with options, you can employ a put hedge or protective put to help minimize the downside loss. If you own mutual funds, you can buy the appropriate index put by determining the type of fund it is (e.g. small-cap, blue-chip, S&P 500, technology).
If you are already adhering to risk-management strategies, good for you! Otherwise, learn them and it will make you a better and more successful trader and investor.
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Tags: investing success, investment advice, investment risk, options, protective hedge, put options, risk management, S&P 500, snall cap stocks, stock crisis, Stock Market Analysis, stock-picking
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George is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. His trading advice on stocks and options is also found on his daily trading site, Daily Profits. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services.
