Control Your Investment Risk

There are several kinds of stock trading strategies, one of which is buy and hold. This refers to an investment approach in which the investor builds up a portfolio of stocks, bonds and mutual funds which are to be held for a long period of time, regardless of market fluctuations or loss of asset value. The underlying premise for this strategy to work is that the stock selections and portfolio composition are correct. However, if they are not, it could end up disastrous for the investor. In the last ten years, investors following this strategy lost about 40% to 60% of their asset values.
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According to investment surveys, most buy and hold investors have no investment plan or even a profit objective. Even in a bear market, many buy and hold investors have been found to be reluctant to sell. In short, they often have no idea when to give up and move on. Not only does this strategy have the potential of heavy losses for the investor, it also incurs opportunity costs (i.e. the benefits that investors could have received by taking an alternative action).

While history has shown this investment strategy works for normal markets, it fails miserably when the financial markets experience major declines across many asset classes, a phenomenon that has become very common in recent years and is expected to remain so in the near future. Given the above, investors should adopt risk controls in their investment accounts in the event of market declines. These could include the following.

• Stop loss orders (i.e. an order to sell a stock when it reaches a certain price so as to limit the investor's loss on a stock position)

• Protective put options that give the owner the right, but not the obligation to sell the stocks at a predetermined price (known as the strike price) until a specified expiration date.

• Board diversification in several stocks or investment assets to manage the selection risk of individual stocks or assets

• A well thought-out exit strategy in which the investor determines beforehand what the acceptable level of risk is and the exit point.

By doing so, the investor is taking a prudent approach towards mitigating the risks involved in the buy and hold strategy, especially in an increasingly volatile market. This is simple stock trading basics.

If you are interested in learning how to pick stocks check out our Two Fold Formula guide to stock picking by clicking here.