While I do have quite a few ideas about some good opportunities, I don't want to simply talk about them without first talking about the third feature of successful investing: Be Vigilant. I think Vigilance is especially important in the current irrational market, as the risk is very high to buy any stocks at the moment. However, if you are vigilant enough, you can significantly minimize your risk while enjoying the very bullish momentum. Being vigilant is to use certain risk minimization measures to trade and invest safely. I think the following four are especially important.
1. Stop Loss
For every stock you buy, you should always pre-define your exit strategy for it. Try to remove your emotion out of the process and get out of the position if it hits the exit criterion. This is the most difficult part for every investor but it is THT most important feature for every successful investor. Without a good exist strategy, your big winner may turn out to be a big loser. The best exit strategy I think is a good stop loss. A (hard) stop loss is simply a specific value, which, if hit, will trigger a sale of the stock. It could be an absolute number or a percentage. For example, if you buy a stock at $10/share, you may decide to sell it if it drops to $8 or drops by 15% of your buying price ($8.5). The idea of a stop loss is to allow you to preserve your capital if you are wrong of a stock or get you out of a disaster early enough during a market crash. The trick is to set the price low enough that you won’t get stopped out on a routine pullback, but high enough that you will limit your capital loss. A range of 10-25% within the buying price for a stop loss is commonly used. The most important thing is that you have to stick to the discipline to sell your stocks when the stop loss is hit. Moving or ignoring stop loss levels almost always results in greater losses in the end. The first exit is the best exit.
For every stock you buy, you should always pre-define your exit strategy for it. Try to remove your emotion out of the process and get out of the position if it hits the exit criterion. This is the most difficult part for every investor but it is THT most important feature for every successful investor. Without a good exist strategy, your big winner may turn out to be a big loser. The best exit strategy I think is a good stop loss. A (hard) stop loss is simply a specific value, which, if hit, will trigger a sale of the stock. It could be an absolute number or a percentage. For example, if you buy a stock at $10/share, you may decide to sell it if it drops to $8 or drops by 15% of your buying price ($8.5). The idea of a stop loss is to allow you to preserve your capital if you are wrong of a stock or get you out of a disaster early enough during a market crash. The trick is to set the price low enough that you won’t get stopped out on a routine pullback, but high enough that you will limit your capital loss. A range of 10-25% within the buying price for a stop loss is commonly used. The most important thing is that you have to stick to the discipline to sell your stocks when the stop loss is hit. Moving or ignoring stop loss levels almost always results in greater losses in the end. The first exit is the best exit.
If you have a winning stock and you want to protect your gain as much as possible, you should use a trailing stop loss. This is a predefined stop loss percentage point from the highest closed stock price after you buy it. In other words, it is a moving point always tied to the highest closed price of the stock. For example, you buy a stock at $10 and place a 15% trailing stop loss. If the stock price drops immediately, you will sell the stock if it hits the 15% point, i.e. at $8.5 of its closed price. If the stock moves up to $20, your stop loss price will be moved up to 15% lower of the $20, i.e. at $17. This way, you will protect your gain along with the upward movement of your stock.
2. Position Sizing
It is self explanatory that you should have an appropriate position size for each stock you buy. Generally speaking, don't let any single position be more than 5% of your total portafolio. Together with a stop loss, this will ensure that a total loss of any single position will not bankrupte you and you will still have enough capital to continue with your other opportunities. No one is totally immune to failure of some positions. It is a normal part of investing. You have to accept that. The key is to preserve your capital as much as possible if you are wrong. Otherwise, it is just a gambling and you will soon be kicked out of the investment game completely.
It is self explanatory that you should have an appropriate position size for each stock you buy. Generally speaking, don't let any single position be more than 5% of your total portafolio. Together with a stop loss, this will ensure that a total loss of any single position will not bankrupte you and you will still have enough capital to continue with your other opportunities. No one is totally immune to failure of some positions. It is a normal part of investing. You have to accept that. The key is to preserve your capital as much as possible if you are wrong. Otherwise, it is just a gambling and you will soon be kicked out of the investment game completely.
3. Diversification
Diversification dose not simply mean you buy many stocks. The idea behind it is to buy asset classes or sectors that are not correlated. For example, if you buy Microsoft, Intel and Google, you are not diversified at all as all the three are tech stocks. For diversification, you may consider different sectors in the stock market such as tech, pharma, shipping, etc, or domestic vs international, or stocks vs bonds vs commodities, or the mix of them. The idea is that if one goes up, the other is probably going down. But it has becomes more and more difficult nowdays to achive this, since many asset classes have become highly correlated. Even stocks and bonds have been moving in the same direction much more often than in the past. Nevertheless, for general investors, it is still a good idea to try to be diversified as much as possible, to reduce risks.
Diversification dose not simply mean you buy many stocks. The idea behind it is to buy asset classes or sectors that are not correlated. For example, if you buy Microsoft, Intel and Google, you are not diversified at all as all the three are tech stocks. For diversification, you may consider different sectors in the stock market such as tech, pharma, shipping, etc, or domestic vs international, or stocks vs bonds vs commodities, or the mix of them. The idea is that if one goes up, the other is probably going down. But it has becomes more and more difficult nowdays to achive this, since many asset classes have become highly correlated. Even stocks and bonds have been moving in the same direction much more often than in the past. Nevertheless, for general investors, it is still a good idea to try to be diversified as much as possible, to reduce risks.
4. Appropriate Hedging
A hedge is a position established in an attempt to offset exposure to price changes or fluctuations in some opposite position with the goal of minimizing one's exposure to unwanted risk. Hedging against risk may involve quite complicated techniques but there are some simple ways to do so as well. Although it may not be a hedge technically speaking, I'd also consider it as a hedge to take profits in time. This is especially true when your stock price increases substantially within a short period of time. Quite often, this will be followed by a swift drop. You may consider to sell portion of your stock shares in this case to lock in some profit and let the remaining run further. If it indeed drops, you may consider to buy back some shares if you still like the stock. More typical hedge can use options to realize that, e.g. buying put options to protect your winning stocks.
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