We continue today with investing basics and talk about risk control.
Using stop-loss limits when investing is an outstanding risk management strategy that always pays off in the long term.
When you take on a position in a stock, you should immediately make note of a stop-loss limit from your entry price, say 20%. You don’t have to do this with your broker; you can easily make a note of it yourself.
A 20% stop-loss limit means that if the stock moves 20% lower in price from your original entry price, you cash out with a loss. By taking this loss, you preserve the rest of your capital to stay in the game. The idea is that your winning stock market positions will pay for your losing ones. This is why you always want to own a basket of stocks, not just bet the farm on one stock.
If you have $5,000 to speculate in small-cap stocks, put $1,000 into five companies and see what happens. Use a stop-loss limit on all five positions. Very likely, some will go down in price and some will go up. The goal is to cut your losing positions and ride your winning positions. It’s a simple strategy that works over the long term.
Now, you don’t just want to employ a stop-loss limit when you take on a new position; you want to have an informal stop-loss limit if your stock goes into profit territory. There is nothing worse than going through the time and effort of finding a great trade, taking the risk, making money, then giving up all the gains because you didn’t take any profits.
So, the best thing you can do is maintain a moving stop limit when the stock trades above your entry price. If a stock goes up 30%, consider maintaining a 10% moving stop limit from the stock’s most recent high. This way, you can consider taking some profits if the stock pulls back.
Remember, absolutely anything can happen to a stock. There could be a war, a strike, a stock market crash — anything. So, you have to take steps to protect yourself.
If you want to protect your wealth, then you must pay yourself first. The best way to do that is in cash. The richest people in the world hoard cash, because they know it is the best, least-risky asset you can own. Stock prices go up and down. Real estate prices go up and down. But cash generates a return on your investment that is often backed by the security of countries themselves.
If you want to protect the savings that you have created, you must maintain a portion of your holdings in cash. You can do this by investing in a money market fund.
As long as the returns on your cash investments are greater than the prevailing rate of inflation, you are ahead of the game.
This is how the rich get richer. Sure, they own large amounts of stocks. They own all kinds of real estate. But they also keep a lot of cash around that generates compound interest, year-over-year. This is how the great wealthy families of the world stay wealthy from generation to generation. They hoard cash and pass it down to their children. Cash is always king, no matter what anyone tells you (or tries to sell you).
Now, even when it comes to a small portfolio of speculative stocks, it pays to keep some cash. Why invest all your money at once in the stock market? Do you really think that there are 10 great stocks that just happen to be very attractive right now? It doesn’t make sense hat the best possible investment opportunities just happen to be when you’ve accumulated a little nest egg for yourself.
Take your time; if you have a pool of cash to speculate with, invest it slowly. Keep the rest in a money market fund until you can build a diversified portfolio over time.
Succeeding at stock market speculating takes time, money and practice. The good news is that it doesn’t take an extraordinary effort, only a consistent one. If you can’t afford to lose in the stock market, then you have to take action to separate your speculative money from the rest of your lifestyle.
With as little as $5,000, you could successfully create a portfolio of stocks that you hope will generate solid returns. Remember to spread your money around a number of positions; use stop-loss limits both on entry price and when a stock goes up in value.
You don’t need to be in any rush to take on new positions. Wait and watch for only the best stocks to come across your desk. Only invest in those companies that you are comfortable with. With diligence and persistence, anyone could be successful speculating in the stock market.