Free trading education: Risk management basics

TradingPub Admin | June 7, 2013

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If you want some free trading education that can help you achieve your investment objectives, learning about the basics of risk management can be extremely helpful.

Risk is inherent to investment
It is crucial for you to keep in mind that risk is inherent to investment. For example, while stuffing money in your mattress or putting it into cash equivalents may seem safe, resources harnessed in this way are still susceptible to inflation risk, which is the possibility that their purchasing power will deteriorate as a result of increases in the price level.

On the other hand, many securities that provide strong potential for returns come along with a significant chance that the value of their principal will decrease. This susceptibility to price declines is called downside risk, and is a major concern to those who want to invest.

When people refer to investments as being more or less risky, they are usually referring to the amount of downside risk. They might also be taking into account how much an asset will fluctuate in price.

Stocks - risk characteristics
A perfect example of an asset that can have volatile prices is a share of stock. This asset class has traditionally generated higher returns than other types of assets such as bonds or commodities, but it is important to remember that these equities can fluctuate in value quite a bit, according to Morningstar. 

Investing in stocks can be a great way for you to generate returns, but you must be prepared for the price volatility that comes along with such ownership. Keep in mind that these changes in price are bound to happen, and be sure to avoid getting too stressed out if the value of your portfolio falls during a day, week or month.

Invest for the long term
The importance of not getting caught up in short-term volatility brings us to another key method that can be used to manage the risk inherent to the stock market - investing for the long term instead of over a short period of time.

If you decide to use a buy and hold strategy, you are essentially doing the opposite of making an effort to time the market. There are many benefits to taking this approach, and CNN Money reports that using this long-term plan can be particularly helpful if you are risk-averse and don't want to suffer an abrupt loss in the value of your investments.

In addition to helping you manage the various risks that are inherent to investing, using a buy and hold strategy provides various other benefits, according to the news source. For example, it can help to reduce trading costs, which can certainly add up if you make transactions frequently. Another area where you can reduce expenses by holding assets for the long-term is taxes. It is important to note that the rates for short-term capital gains are higher than those for long-term capital gains.

Also, there are important psychological benefits to investing for the long-term, since you can save yourself from significant apprehension if you simply refrain from focusing on the daily price fluctuations that will likely happen in your stocks, Morningstar reports.

Another key part of investing is having the right expectations, according to the news source. For example, if you think that you are going to enjoy high returns, you must keep in mind that in doing so, you will likely incur substantial risk, according to the news source. If you hope to obtain 100 percent returns, keep in mind that you will need to engage in highly-risky endeavors to do so, for example buying or selling on margin.

If you want more free trading education, you can find it at TradingPub, home to some of the top investors and traders in the industry.