Stock Market Risk

I am sure you have heard that the stock market is risky. This is certainly true and to be a successful trader it is hugely important to learn how to control stock market risk. It is always a good idea to be aware of what could happen if things went wrong and ensure that it does not have disastrous results on your financial health. Essentially what I am trying to say is, don’t bet the farm!

No matter how experienced and skilled a trader you are, risk is always there. Experience, skill and discipline can often massively reduce the risk, but it is always there.

Even stocks that are considered to be low risk have the potential to fair very badly, even in the long term. Blue chip stocks are stocks in well established companies that are considered to be relatively safe.

Let me just give you an example of one of these blue chip stocks.

We can use the Bank of America stock as an example as many of us are at least somewhat familiar with this company. If you are not, they are a huge American bank whose share price rose from around $5 to $55 between 1990 and 2006. This is around 17% per year compounded over that period and this does not include dividends. This is shown on the chart below.

bank of america chart

Many stock traders saw the Bank of America stock as a relatively safe choice due to the consistent history. However, very few were to predict the scale of the global credit crisis that began in 2008 and caused many banks to require government assistance to avoid bankruptcy.

On March 6th 2009, the Bank of America stock was priced at just $3.14. A catastrophic drop from the glory days of $55 per share. It was a drop of nearly 96%. To view the stock in more detail, feel free to take a look on google finance.

The point I am trying to make here is that anything is possible with the stock market. It is never a good idea to make assumptions. However, history does often repeat itself. Infact a very similar credit crisis occured in the 1930s.

One of the biggest stock market risks is undoubtedly underestimating how badly things can go wrong and not being prepared for it.

Types of stock

It is important to be aware of the diferent types of stock. As mentioned above, blue chips are often the lowest risk, but as demonstrated above, far from risk free.

Penny stocks are often considered to be the highest risk, where as medium sized companies are often considered medium risk.

It is important to ascertain your personal risk tolerance and trade accordingly to it. There is no right or wrong level of risk tolerance, it is unique and individual to you.

Diversify

A good option for lowering risk is to diversify your portfolio. If you have $10,000 to invest, perhaps put some in bonds and a savings account. This way if your stock picks prove to be unsuccessful, you won’t be hurt as badly.

Get Smart

There is no doubt, the odds of being a successful stock trader are against you. Most traders lose money, often a lot of money then give up frustrated. By spending a great deal of time learning how to trade before you embark on your trading journey can greatly reduce the chance of you losing your hard earned cash.