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The key to successful investing is understanding risk

by , 17 November 2014

Being a successful investor isn't all about investing in the most profitable stocks and investments.

It's also about spending a lot of time thinking about the risk you take on when you invest.

It you control how much risk you take, this will help you become a more successful investor. It will also mean you worry less about your investments.

So what exactly is risk? And how can you lower your risk?

Read on to find out…


What is risk?


Risk in the stock market all boils down to the potential of you losing money.

There are various ways that you can measure this.

One way is volatility. Volatility uses the standard deviation to measure how much the price of a stock or investment bounces around over time.

If you want to read more about volatility, go here.

Another way to measure risk is beta. Beta measures how much the returns of a stock move relative to the stock market as a whole.

If a stock has a beta of more than one, it means it tends to move around more than the general move of the market. Some academics claim this makes it more risky.

But this isn’t always the case. Let’s have a look at an example…

The stock market falls 30%. A share falls by 50%. This share would have a beta of more than one. But does that make it more risky?

Can a share be more risky than it was before if it’s lost half of its value?

Beta can be misleading.


Managing your risk all comes down to price


A very large part of the risk you take on when investing comes from the price you pay. If you pay too much for a stock, your risk of losing money is higher.

If you pay a low price for a stock, the risk is lower, Phil Oakley in Money Week explains.

This is the strategy that forms the basis of value investing. In other words buying investments for a lot less than they’re worth.

By buying low, you have a margin of safety. Things can go wrong, but you can still make money because these factors are already priced into the share price.

So there you have it, the key to successful investing is understanding risk.

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