The entrance into investing is almost the same for many people.
The selection of vehicles for IRAs and 401ks is often the beginning of understanding the investment process. Because the goal for growth is long term, many participants are disciplined with their regular contributions and are less prone to trading activity to time the markets.
This more passive style has some advantages with less maintenance, which is the major benefit for people that do not want to manage their money actively. Professionals are responsible for performance and individual investors determine how to position their funds based on their goals and needs. Vast market expertise and dedicating a large amount of time is not required to achieve long term financial goals using some basic portfolio investment techniques.
For many investors, the mutual fund or ETF investment choices fit their needs. Others are looking to achieve higher returns and take on additional risks. Purchasing individual stocks is a commonly the next step in the investment process. The selection process can be fundamental or technically driven but as with all investing, risk control is strongly advised.
One major factor that influences risk is the number of shares or total dollars tied up in an investment. The reality is the worst case scenario of an investment going to zero is a possibility. This should be eliminated if possible. Many techniques from stop losses to protective options are market mechanisms to minimize risk on individual positions.
Stock prices vary and a proper portfolio allocation can decrease risks by diversification. In addition, a consistent dollar investment for all trades spreads the risk more evenly across positions. The goal is to not have any one investment disproportionate to the rest of the portfolio for the sake of financial security. Professional traders attempt to never risk more than 5% of an account on any one position to ensure they have adequate resources to continue with their investment plan.
As well, the price movement can also vary greatly. This potentially changing volatility ranges from stable with less movement to stocks with significant price swings in either direction. A general rule of investing may hold true for these stocks, higher potential returns generally have significantly higher risks as well.
Because of individual stock risks, a plan with an exit strategy is strongly encouraged for trading discipline. Many factors from news, earnings or investment upgrades can greatly affect share prices. Individual stocks, as opposed to a broad based stock index, can have great volatility that can work for or against an investor. The broad based index can offset a loss in an individual position with diversification in many assets.
To quantify or control position risk a stop loss can be part of a solid investment plan. The threshold of loss can be based on share price or a certain dollar amount to determine the exit strategy. Oftentimes, the discipline of having that exit strategy is a downfall for traders and a weakness in a trading plan.
The selection and money management methodology is similar for mutual fund, Exchange Traded Fund and individual stock investment. As financial products get more specific as an underlying instrument, they are often more volatile and higher risk. This requires an exit plan constructed in advance to minimize exposure to negative events. The stop loss is usually the first line of defense and helps individuals control downside risk with the increased reward of individual stock investment.
