Risk and Reward

If you own your investment in the stock market , what would be the first question you would ask yourself before you make the trade or investment ? If your answer is as sound fundamentally is available , or whether the stock just broke out of a trading range on a map , or the fact that the stock is gone by 50 % in the last 6 months , or if the low volatility now it is to buy or sell a good time , then you are probably on the road to ruin . These strategies have nothing in common, and there are all kinds of different criteria , which I will not mention that have nothing in common with each other . But no matter what kind of strategy you use to make investment decisions , there is only one vital question to be asked before you pull the trigger and make the trade must be . That is, what is my risk and what is my reward on this trade. Even if you plan to buy a stock and hold it for a long time , you still have to be aware of your risk and reward . Why ? Since the entire stock market can be here for the rest of your life, not everyone can be a share. You think that's okay, I diversified a lot, so I do not need to know risk and reward. Wrong.
Diversification is great, but you should always be aware of because , investing risk and reward profile also indexes the entire market at risk and have a reward depending on the length of time . Points of entry, exit, stop and diversification , are all important things, but they themselves are not without risk and reward. One has to wonder how much I risk , and what is my potential reward . What are the most important words
Okay, how do I do that ? Well first you need to define your investment strategy. If you want to buy and stick to what exactly that means. Hold for 5 years, 10 years or forever? What is forever? If you are 20 years old always different than if you are 55th Even if you buy and operation , is forever when you invest or stop it is when you start to withdraw money ? These are important questions that must be answered specifically . You could say it does not matter because I will diversify with index funds for the next 15 years. Okay, let me ask this question . Are you 100 % invested at all times ? Do you know the maximum drawdown ( the largest loss from the index high and low for a period of 15 years ) for the index you invested ? Are you financially able to withstand , this type of loss? Okay, I know these are a lot of questions and everything you want to do is to invest in an index mutual fund for the next 15 years , and forget about it.
Well, I will now that if you think you have very little risk at 15 years, you are saying wrong. If the S & P 500 have a 100 % position in 1965 and needed the money in 1980 you would have made ​​no return on investment and had a 40 % drawdown from 1969 to 1975 . If you look in the period 1930-1955 , a period of 25 years is even worse. I know it's the Great Depression and things are different today . Do not assume anything. I 'm not saying that you should not invest. I'm just saying that it's a risk and a reward. Every time you act , whether it a week or once every 15 years , which has made trade a chance to win once and a chance to lose . Even if you buy a managed fund for 15 years you are not buying and holding . They buy and sell, but you pay a professional to do it for you . He or she will have to pull downs in the fund and hopefully he or she will look at risk and reward for you. Even an index fund holds for 15 years , will not actually buy and hold because the indexes change on an annual basis . Some stocks are in the index and some stocks go from the index. The longer the time period , say 40-55 years , the greater the risk , but the bigger the reward. Also, the longer the period , the longer you can withstand a large drawdown , if it comes.
Now what if you are already predefined with one input and one output point trading stocks , that's where I get in and where I get out . This strategy might be good, but that is not without risk and reward. The main question is , how much I invested and how much I need to get out . What is the % of the risk on each stock in the portfolio and what is the risk of the entire portfolio . Let's take an example . You bought 100 shares @ 50 IBM for $ 5,000 to a total stock of $ 200,000 . Make a sell stop loss on all 100 shares to sell if IBM goes to $ 40 / share . This means that the risk of IBM is $ 10 / share , or $ 1000. But your real risk to your portfolio is 0.5 % or $ 1,000 of $ 200,000 divided . If you have a sales order exit point of $ 100 , then your reward in the stock market would be 100 % and the reward of your total portfolio was 2.5 %. So your overall risk to reward was 5-1. You could crunch numbers all day making formulas to fit your strategy, but the important part is how much you are risking . Here are some general rules when it comes to the risk :
Do not risk more than 2 % of a particular profession or idea. It does not matter if your strategy technical or fundamental or discretionary . Risking 1% would be safer . Most large fund managers risking much less.
Diversify . Purchase 1% risk on IBM and Dell, and 1 % to 1% on Hewlard Packard is a 3 % risk , because they sell all offering the same products
Do not risk more than 20 % of your portfolio at a time , 10 % would be better. You must find a way to quantify the greed factor , or it could consume you and all your money at the same time .
In my own portfolio, I try not more than 7 % on an initial portfolio risk position.
Initial risk and risk may be going on two different risks. As the amount of trading profitably in danger at any time , a variable can not be a constant . That would be for letting profits run while cutting losses short to allow . However, you would risk your initial one variable in most cases a disaster. After initial risk is understood it should never be increased. Greed may be the primary factor in increasing initial risk and that's always a fast track to increasing losses .
I hope that risk and return profile of the primary strategy to invest in your future and become a concern trade.
John McKeon - pivate placement fund manager and owner of  , an investment newsletter. I also have more than 25 years experience in trading with a specialization in stock index trend following.