Risk management is the Achilles’ heel for many investors. Without proper risk management profit will come and go. Maybe you have experienced such a scenario yourself and are looking for information on how to do risk management. In this post, I’ll go over topics about mindset and what to do to incorporate risk management.
Disclaimer: None of what I’m talking about should be considered as financial advice. It is for entertainment and educational purpose only.
Understand Your Downside
In an ideal world, you would invest with capital that you can be okay with losing all of it. However, in practice, that’s not always the case. Maybe you started out with capital that you can lose it all but then you start adding more and more then next thing you know you got a lot more on the line. Even the most disciplined of investors can end up in such a situation. So, it is important that you regularly check in with how much you have at risk.
You’ll need to determine if how much you have invested is too much for you or not. Imagine if a particular investment went to 0, would you be fine? Would you be concerned with how you can put food on the table? If losing that amount of capital gives you concern about how you’ll get by then it means you need to take some chips off the table. Remember the first thing is to preserve your capital and the second is to grow it.
Lower Your Risk and Put Yourself in Position of Strength
When you’re up huge in an investment say like 5x, what do you do? Some would let it keep running and do nothing. Some would sell it all. In both situations, it can lead to some major regrets in the future. You could have sold everything and seen the price keep skyrocketing. You could have held everything and seen the price plummet and all your gains are gone.
What if I tell you there is another option? You can sell enough to get your initial capital back and let the rest run. This strategy works well when you’re up huge because getting your initial capital back is a small portion of the overall investment. It also puts you in a position where the absolute worst is you’re breakeven with a high chance to make some profits. Being in such a position will put you at ease because you can only win.
Don’t Chase
When something goes up hundreds of percent it is not the time for you to chase and get in. Why not? The price seems to keep on going up. Well, that’s because you need to think about the seller’s side. They got hundreds of percent in profits, you don’t think some of them would sell? If you get in, you’ll just end up being the seller’s exit liquidity.
Once in a while, you’ll encounter an asset that would run and hold its value. Yes, you’ll miss the run by not chasing, but you’ll also avoid getting burned by buying at the top. The majority of the time, after a big run up the price would not hold and there would be a correction. That’ll be your opportunity to get in when others are fearful of the correction.
Identify Your Price Targets
Getting into an investment is easy. Knowing when to get out of an investment is hard. One way to help you exit an investment is to identify some price targets where you’ll sell or re-evaluate to continue holding. It’s important to have a plan that way you don’t go into an investment aimlessly. It is also important to remember that your price targets are not set in stone. If the fundamentals change you can always update your price targets.
Learn to Take Profits
Until you sell, all your profits are paper gains. The profits you see are not guaranteed and can change drastically in minutes. It is only when you sell do you lock in the profits. Therefore, it is important to periodically take some profits that way you realize your gains and lower your risk.
There is a lot that goes into taking profits. It is a skill that takes time and practice to do well. When done right, it would give you the majority of the profits while significantly reducing your risk. If you’re interested in finding out more about profit-taking I have a dedicated post for this subject.
At the end of the day, when it comes down to investing there are two key things. They are capital preservation and capital growth. Too many investors are fixated on capital growth and neglect preservation. Without capital preservation, you can’t grow your capital. Without risk management, you’ll have a tough time preserving your capital.
I hope this post was helpful to you. If you found this post helpful, share it with others so they can benefit too.
If you’re new to investing and need a guideline to help you start your investment journey you can check out my post on setting yourself up for financial success. I also have a post about beginner mistakes to avoid in the stock market.
To get in touch, follow me on Twitter, leave a comment, or send me an email at steven@brightdevelopers.com.