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A simple method to manage your risk when investing

by , 13 December 2018
A simple method to manage your risk when investing
When you invest in a share, there's always certain risks involved….

Competition, new regulations, the economy, currency…just to name a few.

The problem is, it can be hard for investors to quantify all these potential risks.

Rather than develop a complex, but flawed, analysis of risk... it's more helpful for an investor to think of "risk" in a simpler form…

“How much could I possibly lose?”

It's more useful to simply think of risk as the money you could lose on any one investment.

So if you normally invest R10,000 in a share with a 25% stop loss, then your usual level of risk is R2,500.

Sometimes you may wonder if you should use a different percentage at certain times.

Well, let's say you buy a penny share that has the potential to make a big move in a short period. (Remember, penny shares are usually volatile, which means they can quickly rise and fall in short periods).

Holding a penny share with your typical 25% stop loss could force you out of the stock before you can capture the gains.

Instead, say you want to hold it with a 50% stop loss. But now look at what that does to your risk...

With that R10,000 investment, you're now risking R5,000.

You've doubled your risk.

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Here’s how you can reduce that extra risk with one simple step

If you want to keep your risk level to R2,500, you would reduce your initial investment to R5,000. You could also go even smaller to risk less investing in a more volatile stock.

As a basic guideline…

We tend to recommend a 25%-35% (it can go higher depending on the stock) stop loss for more volatile positions like penny shares or resource companies.

This will allow for swings in share price that these markets are known for without kicking you out too early.

Similarly, you can use a 15%-25% stop for less volatile positions, like well-established companies that dominate their industries.

Just remember as an investor, having an exit strategy is vital to your success. Stick to it, and it can serve as a near-fool proof way to cut your losses and let your winners ride.

See you next week,

Joshua Benton,
Managing Editor, The South African Investor

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A simple method to manage your risk when investing
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