Before anyone begins investing, it is essential to understand some of the basic principles of investing. You must understand risk, return, volatility, and risk tolerance. When we did find a risk in investing we can define it as the uncertainty of investments return. Before you begin investing you likely had a savings account where your return was guaranteed and therefore carried no risk.
Depending on the performance of an individual stock your potential return could double or could quickly become worthless. Volatility then defines the degree to which a value of an investment tends to fluctuate over time.
One basic principle of investing for the beginner or the veteran stock picker, risk and volatility go hand in hand with investment returns, the higher the risk, the higher its volatility and potential returns. Investments with high risk and volatility have a greater chance of losing value is held over shorter periods of time, say less than five years. The effect or chance of a stock increasing in value over longer periods of time worked the same way.
Risk tolerance is defined by the amount of risk that you, the individual investor, are willing to withstand and be comfortable with in your investments. Not identifying what kind of risk tolerance you possess can surely lead to investing disaster.
Determining your risk tolerance is easy once you identify two very important factors. They are your time horizon for your investments, essentially how long you plan to hold your investments, and your personal response to risk. That means, what decision are you likely to make when you’re investment loses 15% in a day.
Obviously the longer you can hold your investment the more risk tolerance you are able to withstand. The longer period of time keep you from making hasty decisions over short-term ups and downs in the price of your stock. Longer-term can be defined as 10 years or more. Investors with moderate time horizons, say 5 to 10 years generally have moderate risk tolerance and should invest in growth and income by investing in stocks, bonds and cash equivalents.
Investors were shorter time horizons one to five years generally have low risk tolerance should invest almost entirely for income by buying bonds and cash equivalents. There is some correlation between risk tolerance and age however, that doesn’t apply across the board to everyone. Identifying your personal response to risk should include an examination about how you feel personally about taking risk in losing money. If you avoid risk in everyday life chances are you should avoid it in your investment strategy.
For example if you worry on a daily basis, that will easily trans-late into worrying about your stock investments. If you enjoy risk and don’t worry easily you should feel comfortable investing for growth or trading options online assuming you have a longer time horizon.
One of the best ways to identify how you will respond to market fluctuations and risk is to own a stock. Let’s say an issue at $20 per share. Over three months the stock appreciates and gains four dollars a share to $24. You begin by feeling pretty good about yourself having picked the winner and you are enjoying a nice gain. Now, through no fault of your own, earnings start to come out by companies related to the industry of your stock. Since they are not good your stock loses eight dollars per share over four days. Ask yourself this question, how would you react in that situation? If you can answer this question and answer this question truthfully you are on your way to identifying your investing risk and risk tolerance factors. Not everyone is comfortable trading in Forex Mini Accounts, and not everyone wants to trade in bonds. Everyone fits in somewhere, find your place and you will be a much happier investor