Investment risk management includes diversifying to balance business risk, being wary of overpriced stocks, and not confusing short term goals with long term investing techniques. Picking new winners is always the name of the game but picking them at the best price, diversifying to reduce sector risk, and choosing stocks whose prospects match your long term goals are good ways of managing investment risk.
Business risk is the risk of competition. Effectiveness of management, developing and promoting products, penetrating markets, and doing so in the most cost effective and profitable manner all go into a profitable company. Business risk is also economic risk. Macroeconomic circumstances such as recessions and wars can devastate otherwise thriving businesses. New scientific discoveries or new technologies can likewise create new winners and losers. Diversification helps in managing investment risk. Consumer product companies typically do better during a recession than oil companies. Owning different types of stock in several market sectors will protect you from an isolated market downturn in one sector.
Fundamental analysis of stocks includes a careful look at price to earnings ratios and cash flow ratios. These details will tell you if a stock is overpriced or underpriced. They will tell you how effectively the company is using its cash flow. Fundamental analysis of a stock will tell you if it is a good buy or if its success has caused it to become overpriced. Many companies have their day of rapid expansion and eventually grow to a size that inhibits spectacular growth. They are typically priced in anticipation of future earnings. Managing investment risk in buying stocks has to do with not overpaying for popular stocks on the one hand and finding underpriced stocks on the other. It also has to do with being able to define investment risk.
Investment risk management probably best starts with having a clear idea of what your investment goals are and developing an investment plan consistent with your goals. There are many stocks that have appreciated in value over many years. Long term investing is best served by finding underpriced stocks with good prospects, buying and holding. However, almost all stocks suffer when there is a market crash. If your goal is to make a certain amount of money in a few years you may be disappointed when the economy turns sour just when you want to sell and take profits. Managing investment risk for short term goals is easier with trading options where there is profit in both the rise and fall of stock prices. Knowing what penny stocks to watch for short term gains may be a better idea in a volatile market where you want to keep your gains as cash.
Investment risk management works best when you don’t let everyone else’s mood affect yours. Polls tell us that the American public is very pessimistic about the economy despite the fact that the economy is improving, retails sales are coming back, and manufacturing is picking up. Whether you are investing in oil, investing in gold, or investing in beer companies keep your eye on financials and fundamentals as your guide to managing investment risk.