Different investors have different investing styles. Some are
aggressive some are not. But to me, the most important thing to
do in investing is to minimize your risk. Why is it important?
Simple. Because, we as a human, hate losing. Research has shown
that investors tend to hold losing positions for too long and
sell winning investments far too soon. The general consesus is
that you have not lost when you do not sell your losing
investments.
Aside from that, taking care of risk first is critical to your
investment success. This is because it takes you to gain larger
percentage in order to cover your loss. Look at the list below
for clarification.
% loss: 25%, % gain to break even: 33% % loss: 33%, % gain
to break even: 50% % loss: 50%, % gain to break even:
100% % loss: 75%, % gain to break even: 400% % loss:
90%, % gain to break even: 900%
Let's use the following example; If stock A fell 50% from $ 100
to $ 50, A needs to rise 100% from $50 in order for investors to
break even. If you go down the list, the climb gets harder. If
you invested in stocks that lose 90% of its value, it needs to
climb 900% for you to break even. Wow. This demonstrates the
importance of controlling your risk.
Here are a few checklists to help you to reduce risk in stock
investing:
Positive Net Cash. Companies having positive net cash has
less chance of bankruptcy and hence, your risk of incurring
large percentage of losses. In bad time, the company can use the
extra cash to defend its position rather than selling off its
valuable asset to cover debt payment.
Dividends. Companies giving out dividend is a sign of
strength. Without strong cash flow generation, companies cannot
pay generous dividend to its shareholders. Furthermore,
companies giving out dividend has less room to fall since value
investors will quickly snap it up if share price goes down too
deep.
Modest Price Earning Ratio. Companies trading at modest
P/E ratio implies modest expectation. Stock price will be less
volatile to 'beating the expectation' game. This protects you
from volatile price swings. As a result, you reduce your risk of
losing out huge amount of your investment.
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