Risk in the stock market is everywhere. Investing in the stock market is fraught with worry, for good reason. If you lose half of your investment, you must double your return to just breakeven. Warren Buffett, considered by many to be the world’s greatest investor, states his first rule of investing is “do not lose money.” Unfortunately, the risk in the stock market of losing your money is always a possibility. However, without taking some risk there is no reward. Therefore, successful investors employ stock market risk management strategies to minimize their losses. Managing risk in stock market starts with identifying the type of risk and taking action to mitigate the impact of the risk on your investment portfolio.
Risk in the stock market comes in many forms and each can lead to a loss. The most common is the overall trend of the market. Approximately 60 % of the move of an individual stock is attributed to the trend of the stock market. If the stock market is rising, it takes with it most of the other stocks, though not in equal amounts. When the stock market falls stocks sink with it.
Another big risk in stock market lies with owning an individual stock. While owning the stock of a company can offer greater rewards, it also entails the risk that something might go wrong that can cut the price of the company’s shares in half. It might be news that sales have suddenly fallen due to a new competitor, or a product liability issue has arisen. For whatever the reason, individual stocks are subject to risk associated to them alone.
While there are other risks in the stock market, these encompass the vast majority of the ones you will encounter. Fortunately, investors can employ several strategies as a part of their stock market risk management program.
First, they can invest with the trend of the market. Following the trend is a proven method, though it is not as easy as it sounds. Trend following tries to identify and then align with the underlying trend of the market. The assumption is the market will be in a trend that could last a day, a week, a month a year or multiple years. Generally, short-term trends cycle within longer term trends. Depending on your time frame, you can align your stock position with the trend once you have identified it. When you follow the trend, you are able to reduce the likelihood your stock will fall when the market trend is rising.
Another proven risk management strategy for owning stocks is to diversify your portfolio across several different companies, sectors, and asset classes. By owning several different stocks, you reduce the impact of a loss in any one company. Moreover, if the stocks you own are from several different industry sectors you mitigate the impact of any one sector have causing a loss. Exchange Traded Funds (ETFs) offer an excellent way to add diversity to your portfolio as they hold shares of companies based on an index. The index can be for the whole market, or any segment of the market. When using ETFs, be sure there is sufficient liquidity (plenty of shares trading) or you will create another unwanted risk.
Many investors size their stock position based on their tolerance for risk. Dr. Van K. Tharp performed an experiment on position sizing in his book Trade Your Way to Financial Freedom . As Dr, Tharp found adjusting the size of your stock position using percent risk or volatility greatly increases your returns. By adjusting the size of your position based on the risk you are willing to assume, you lower your potential of a loss and increase your probability of solid gains. Our article on Position Sizing provides further detail on this method to manage stock ownership risk.
Should the price of your stock turn down, wouldn’t it be nice if you could exit your position before the price fell further. Stop loss or trailing stops are tools used by many investors to close their position should the price fall by a specified amount. Most brokerage firms allow the use of stops using a set number of points below the price or a percent below the price. Trailing stops follow the price up by an amount you set and then hold that price level on any turn down. The idea of this stock market risk management technique is to leave enough room for the stock price to fluctuate within its up trend, but be ready to sell should it fall below a pre-determined level. Some investors use mental stops, which work well as long as they have the self-discipline to sell when their stop price is hit.
Many people believe equity options are risky investments. It is true that options can be risky as they increase your use of leverage. However, professional investors use certain options to reduce the risk of their portfolios. Covered call options are an excellent way to create some down side protection while increasing the potential return of your portfolio. Covered calls are suitable for IRA accounts, indicating that the authorities consider them a low risk investment strategy. Protective put options are another method to lower risk of a portfolio. Similar to insurance, protective puts provide security should your long positions suddenly fall in price. When that happens the put option guarantees you will receive the agreed upon price for your stock no matter how far it falls. You can learn more by reading articles on covered calls and protective puts that describe the features and benefits of these stock market risk management strategies.
Managing risk in stock market is a matter of doing all you can to avoid losing money. Fortunately, there are several strategies to help you to achieve this important goal. The most successful investors employ all of stock market risk management strategies that recognize how important it is to avoid making a mistake while investing in the stock market. Do your portfolio a favor and use the available stock market risk management techniques to your advantage.
Principle: Hans E. Wagner, CEO of Trading Online Markets LLC and Peregrine Advisors LLC
I began investing in high school and have remained active in the markets. A graduate of the US Air Force Academy with an MBA majoring in Finance from the University of Colorado, I continued to invest throughout my career in the US Air Force, Bank of America, Coopers & Lybrand, and working for Ross Perot before retiring at 55. During that time I have gained a very good understanding of what works and what doesn’t. I hope to impart that knowledge to others, so they can achieve financial independence as well.
MEG Financial Comments on Berkshire Hathaway Downgrade by Fitch for “Key Man Risk”
Pensacola, Fla. (PRWEB) April 7, 2009
MEG Financial, founder of www.keypersoninsurance.com , a specialized national provider of key man insurance, is warning businesses of all sizes to hedge against “key man risk”. Successful companies that are dependent upon one or more key people need to seriously consider key man insurance to protect against the potential loss of an indispensable executive.
The recent Fitch Ratings downgrade of Berkshire Hathaway (NYSE: BRK-A)(NYSE:BRK-B), one of the nation’s best run and most respected investment holding companies, emphasizes how important one individual can be to the success or perceived success of an organization. In fact, one of the main reasons Fitch provided for cutting the financial ratings of Berkshire Hathaway was the “key man risk” linked to Warren Buffett’s ability to continue to negotiate deals and make investments on behalf of the company.
The Ultimate “Key Man”
Warren Buffett, the 78 year old “Oracle of Omaha”, is the Chairman and CEO of Berkshire Hathaway and its largest shareholder. He is known the world over for his ultimately successful value investing strategies and as of 2009 ranks second on the Forbes list for richest people in the world. His significance to Berkshire cannot be overstated which is why Fitch emphasized “key man risk” as a reason for the downgrade.
Losing a Key Executive Would Seriously Impact Most Companies!
Key employee exposure is not exclusive to large publicly traded organizations like Berkshire Hathaway. In fact, small and medium sized businesses are even more reliant on the talents and experience of a select few. In these cases, it is even more crucial to protect the company from the untimely death or disability of a significant bottom line contributor. In fact, in smaller organizations, one individual can be so vital to the overall success of a business that if they leave the company, become disabled or die, the company dies as well. However, the good news is that there is an easy and inexpensive way to protect against the risk of the loss of a key employee or executive.
Key Person Insurance is the Best Solution to “Key Man Risk”
Key man insurance, commonly referred to as key person insurance, is the most effective and efficient tool a business can use to guard against the death or disability of a highly valued employee or business owner. For years, companies both large and small have purchased and owned both key man life and key man disability insurance policies on the lives of their strategic people so that business continuity can be maintained in the unforeseen circumstances of a death or disability.
Don’t Be Shortsighted When It Comes to Buying Key Person Insurance!
The recent downgrade by Fitch of Berkshire Hathaway, one of the largest and most highly respected companies in the world clearly emphasizes the need for businesses of all sizes to consider key man insurance. If Berkshire Hathaway can be downgraded for its exposure what company is immune to the “key man risk” of losing a master technician, top salesperson or CEO?
For additional information on key man insurance, contact Michael E. Gray, Jr., Independent Insurance Agent and President of MEG Financial or visit our website keypersoninsurance.com
MEG Financial:
For the past 15 years, MEG Financial of Pensacola, Florida, a nationally known key man insurance specialized brokerage firm, has worked with businesses to secure key man insurance and to promote it as an intelligent and inexpensive way to protect against “key man risk”. MEG Financial’s key man website offers instant key man insurance quotes for companies of all sizes across the country.
Contact:
Michael E. Gray, Jr., Independent Insurance Agent and President
MEG Financial
(877) 583-3955
www.keypersoninsurance.com
CA 0C39049
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