The stock market is a zero-sum game. For you to earn money, someone has to lose out and vice versa. Before any investment is made, peoples greatest fear is losing money and the stock market is no different. This is especially try in todays volatile market. So here are three ways to help you guard against wild market swings and help you limit losses.
1) Lower your costs – Costs are a big detriment in the investing world. Costs eat away at profits when the value of your portfolio rises and increase any loses during a downturn. There are a couple of ways to reduce your costs:
- Don’t trade too often: Many people trade often out of fear – selling any stock too quickly that is going down and buying any stock that is going up in the short-term. The problem with this strategy is costs will eat into your profit margin. It is more beneficial to buy and hold an investment long-term rather than trading very often.
- Ditch funds with high fees: Many funds today still charge high fees. Buy unbundled funds rather than inclusive funds to reduce costs. Taking it a step further, i would argue that you should buy an index fund and just hold this over the long-term.
2) Use stop orders – With stop orders, you only lose the amount you are comfortable with. So if you decide you can handle a 15% loss and no more, place a stop order at 15% less than the price you paid for the stock.
Stop orders will help you from over trading and will help you realize smaller losses than you would otherwise face in extremely volatile markets. Stop losses are particularly helpful during times you don’t have access to your investment accounts like when you are on holiday. They erase the fear of you losing tons of money and help put your mind at ease.
As with most trading tools, there are disadvantages. Stop losses are affected by short-term price swings so make sure you put them at an optimum level and review them every so often. When in profit, you can put your stop order above the price you initially paid for a stock and this way even if the stock price crashes, you will still make a profit on your investment.
3) Keep your emotions in check – It is human nature to let emotions dictate the way we think. Emotions add risk and it could make you sell your investments at the bottom of a stock market or make you want to buy more stocks at the top of the market.
This is why it is best practice to have an investment plan to help separate emotion from your investment decisions. Instead of looking at short-term losses or gains in isolation, look at the long-term scenario.
Sometime going with your gut feeling and letting emotion rule you is a good thing as many good investments have been picked up this way. But limit any gut-fueled decisions to no more than 10% of your portfolio as its risks far outweigh its benefits.
Investing in the stock market is a tricky old game and there is no way you can completely insulate yourself from losses. But if you follow the above three rules in conjunction to the main principle which is diversification, you could limit your losses and achieve higher gains in the future.