- Make sure you never lose money!
- Don’t forget the first rule!
People say that investing in the stock market is risky. They call it gambling. I strongly disagree with this statement and I’m going to show YOU what kind of risk is involved when investing in stocks. If you use the risk management strategy that I’m about to share with you, it’s almost impossible to lose a nickel and the profits can be huge.
What Happens If You Don’t Have A Proper Risk Management Strategy?
The biggest risk of all is losing all of your money. There are two scenarios that can make it happen:
- To use margin trading, which means trading assets with funds provided by a third party
- To invest all your money in a single company and that company to go bankrupt. That is the worst-case scenario and not even then the share price doesn’t reach 0.
How Does Diversification Work In Your Favor?
Let’s see what are the chances of losing money if you use diversification.
First of all, you should check what are the chances that a company would go bankrupt. In 2009 the number of companies listed on the Stock Market that went bankrupt was 211. That’s the record so far. Accordingly, to Google Finance, the number of companies that you can invest in on the Stock Market is over 33 000. So the chance for a company that you have invested in to go bankrupt is less than 1%. So the probability of all of your 20 companies going bankrupt is 0.00000000000000000001.
I have to be honest with you and warn you that there is always a risk involved when investing in the Stock Market, especially if you are a newbie and don’t know much about it. But following these simple rules will reduce the risk considerably.
Maybe the most important rule of diversification is to have 50% of your investing funds available in cash in a bank account. You can lower this amount at 30% in case of a market crash when you can buy shares at ridiculous prices.
Value Investing is a suitable strategy and you should have good long-term results with it. In some cases, it may take longer for investors to acknowledge the real value of a company. Until then, the price might fall considerably, depending on the market conditions.
To summarize, here are the four rules of your risk management strategy :
- Invest only your own money, don’t borrow from your broker.
- Have a diversified portfolio, between 20 to 30 companies, according to your capacity of following these companies.
- Your portfolio should be balanced ( almost the same amount invested in each company)
- Keep 50% to 70% of your investing capital in cash. Otherwise, you could be breaking both of Warren Buffet’s golden rules.
Make sure you read the next article to learn how to always pick a winner when investing in stocks!