Regardless of account size, proper allocation and position, risk control is crucial for success. Large portfolios may have the resources to ride out drawdowns but that doesn’t necessarily that is the best financial choice. A solid plan with money management parameters set up in advance can keep your investment on the chosen course.
Professional traders often manage their positions differently than the average investor. They focus on controlling risk and quantifying what that exposure means to their overall portfolio. A novice typically does not spend as much time planning the exit strategy and can be prone to emotion instead of trading discipline for execution of a plan.
The exit, both on the positive and negative side of the ledger, can be determined by several means. A specific dollar goal or loss with a stop loss order could trigger an exit, according to decisions made prior to entering the market. A percentage move or an amount related to the trading range could be a methodology for financial discipline.
One method of risk control is the use of protective stop losses that stand in the markets and are executed if prices trade at or through desired levels. This simple strategy is probably the most common way for investors to control risk without constantly monitoring positions throughout the day. The plan can be executed by a broker with open electronic orders that are in effect until otherwise cancelled.
Investment portfolios may be allocated in many ways. The simple concept is to divide the total pie into separate pieces with diversification to spread overall risk. The investment risk can be general from bonds, stocks, to mutual funds. Also within those asset classes it is important to minimize exposure to sectors or positions.
The more heavily an investment portfolio is weighted in any industry or sector the more sensitive it is to that performance. There will possibly be a larger impact both positive and negative for the overall returns than in a balanced diversified account. The “putting all of your eggs in one basket” theory can be dangerous and is a risk that most professionals avoid to better ensure long term survival.
Money managers often focus on consistent yearly results and minimizing account volatility. Part of that money management methodology is limiting financial risks to a certain percentage of the overall account. A basic rule of not risking more than 3-5% on any one position allows the investment pie to be cut into many pieces. If any one investment fails under this scenario, over 95% of the account is still intact.
When trading vehicle and position diversification have been carefully incorporated into the investment portfolio, it may also be necessary to set up accounts for different needs. The goals and objectives of different investments are often divided between appropriate accounts. Investment methods can be much different for retirement than speculating using options.
Separating the accounts physically is a technique to minimize the differences in investment strategy and goals. It’s common for individuals to have an account that is more aggressive or takes on greater risk than retirement or college funds. The differences in the psychological and mental approach make it necessary for most to have multiple trading accounts.
The basic rule of divide, diversify and different accounts should apply to all investors. A trader with a minimal account has to be especially careful because investment mistakes can be catastrophic to survival. A solid investment plan based on percentages can be translate discipline to accounts large and small.
