Financial Risk Management
The Smart Profits Report: Issue #423
Wednesday, May 23, 2007
Financial Risk Management: Know Your Risk Tolerance Before You Trade
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research
As I pushed the button to call the elevator, a guy walked up beside me and got on. He pushed the button for his floor and turned to ask what floor I needed. As I looked over, I recognized him instantly. It was Jeff Garcia, the three-time Pro Bowl quarterback. Just to make sure I was right, I asked him if he’d spent any time in Philadelphia last year.
He chuckled a bit and said, “Yes.” If you don’t follow football, Garcia almost single-handedly resurrected the Philadelphia Eagles’ season last year, leading them from impending disaster to a playoff spot, where they fell one win shy of the conference championship.
So what does my encounter have to do with investing? It concerns the critical area of financial risk management. Let me explain…
Financial Risk Management: Investor… Know Thyself
I was teaching an investing workshop at the hotel, and Jeff Garcia was gracious enough to chat with me later that evening about how he invests his substantial NFL salary. And when we talked about his investment strategy, he told me a tale of two investors…
- When he first broke into the league and had some money to invest, his money manager took on much more financial risk than Garcia liked. It got to the point where Garcia was so uncomfortable with the strategies that he had to pull his money.
- Since then, he’s found an advisor who really understands his goals and financial risk parameters. He’s let this guy handle his money for many years, and I could tell by the look on his face that he’s truly comfortable with the way he’s doing it.
This is a crucial point - and brings us to our own coaching session. So let’s see what we can learn from a Pro Bowl quarterback…
It’s always strange to see how many investors ignore this point… but if you don’t know your tolerance for risk before you invest in the stock market, it’s going to be tough for you to know when to get out. But fortunately, these tips should help you with your financial risk management…
Know Your Goals & Your Financial Risk Parameters
Most people start investing with a simple goal: “Make as much as I can as fast as I can.” While it sounds good in principle, this unfortunately leads to the opposite effect: Losing as much as possible as quick as possible. Here’s why:
- Sure, it’s possible to make huge profits from investing. But to do that, in almost all circumstances, you have to take huge risks.
- And most folks aren’t prepared, either psychologically or from a knowledge perspective, to take on this kind of risk.
- So when they do, disaster is almost assured before they even start.
And while some very high-return, relatively low-risk opportunities do exist, they are few and far between. For almost all day-to-day opportunities, the markets force us to accept larger levels of financial risk when seeking out higher returns.
Know When To Trust Your Gut
When I heard Jeff Garcia talk about how high investment risk levels scared him, I was pretty amused. Here’s a guy who weighs 190 pounds dripping wet, yet on any given Sunday, he’s got some 350-pound defensive tackle staring him in the eye, with the sole intent of doing him massive bodily harm. To me, that’s “high risk!” But for Jeff Garcia, it’s routine.
When I told him this, he laughed and said they’re different types of risk. He’s right. When Garcia thought his portfolio was at risk, he just did the same thing he does when a monstrous defensive lineman is chasing him: He ran the other way - and fast!
This probably saved him a huge amount of money. And you can do the same thing. When you feel uncomfortable with the level of financial risk you’ve taken on, don’t lose sleep by staying in those positions, waiting for them to potentially nail you. Instead, move into something that better suits your tolerance for risk. You’ll sleep better when you do.
Know That You Should Care The Most About Your Money
While money managers and financial advisors are often great, some of them take on extra financial risk in search of higher returns… and higher commissions. If you sense danger in your portfolio, don’t be afraid to take matters into your own hands and move the money. Don’t let hot tips, pushy friends or relatives, or perceived tax benefits persuade you to do something that makes you uncomfortable.
I found Jeff Garcia to be a truly likeable guy - unassuming, humble and polite. Even the notoriously tough Philadelphia fans grew to love him last season. And his investing experiences through financial risk management have some good lessons for us all.
Great trading,
D. R. Barton, Jr.
|
Today’s Smart Profits Action Center
- Although the stock market is riding high right now, remember that bear markets are usually triggered during good times. Don’t get washed away in the euphoria and ignore your financial risk management strategies. Professional investors always pay attention to risk; amateur investors fall into the trap of abandoning it as they chase higher returns. As investment expert Dr. Steve Sjuggerud says, “If you focus on the risks, the returns will eventually come for you. If you focus on the returns, the risks will eventually come for you.”
- One of the best ways to manage your financial risk properly is through “position sizing.” This basically means you invest the same amount in each of your positions, thus ensuring that you’re not risking any more money than you’re comfortable with - and more importantly, that if a trade goes bad, it can’t cripple your portfolio. Decide how much you want to risk, then stay disciplined and stick to that number. Learn more in Smart Profits #193 , Position Sizing: The Most Powerful Investment Concept.
- If you really want to manage your financial risk more effectively and maximize your gains in the process, you’re going to need more than one investment approach and more than one trading strategy. To see how one group of professional investors do this all the time, resulting in gains of 80%, 48%, and 46%, click this link.
Related Articles:
- Risk Management and Position Sizing: Three Ways To Give Your Trades A Tune-Up
- Risk In Investing: Don’t Take Insane Risks When You Have Options
- Become a Better Trader: Small Changes You Can Make for Big Profits
The Chart Of The Week
It’s tough to find many folks with anything good to say about the dollar these days. But bear in mind that when sentiment goes that negative, it usually means the market has stretched too far. The Euro made a new all-time high versus the dollar in April before retreating by 200 ticks. While this could be just a normal pullback before it makes an assault on new highs, it’s more likely that the dollar will strengthen in the intermediate-term, making it a less “hated asset.”
How One Company's Groundbreaking "Cancer Blaster" Could Make You Rich
While the World Health Organization predicts 12 million people will develop cancer in 2009, this little-known company is fighting the surge with its amazing cancer-killing device...
Although most people know nothing about it, this "Cancer Blaster" has already saved thousands of people around the world... Like Ohio resident, Caroline Brubaker, who says "with just three, pain-free outpatient visits, I had my life back" or Richard Swanson of Arizona who ended up cancer-free after just 4 hours of treatment...
The best part is, the company recently discovered an extraordinary breakthrough that could go mainstream in a matter of days... Read the full details to find out how you can get in ahead of the event - and be on your way to booking truly incredible gains.
|
