Speaking to a group of investors on Wednesday about Risk Management brought the point home to me again how important it is to manage each position in our portfolios relative to the markets each day. It is easy to get lulled to sleep by this current market environment where everything we do seems to work. Technical analysis is working with breakouts, swing trades, pattern trading, etc. The challenge is not confusing a bull market with intelligence. Bull markets make us all look smart, but the smart investor knows this doesn’t last forever, and the current uptrend is increasing the downside risk of positions in our portfolios. There are three vital things we need to define, and remind ourselves about every position in our portfolio:
- Purpose – the why of what we are doing overall and for each holding in our portfolio. If you have obtained the purpose on any or all positions in your portfolio… manage the risk of continued ownership and not forfeiting the accomplishment of the purpose. Focus and remember why you bought each holding. Keep a journal for each position you enter and why. Refer to it often and stay committed to the original purpose of the trade. Simply put… invest on purpose.
- Strategy – Have a defined strategy for how you with enter the trade, exit the trade and what you will do when you accomplish the goal of the trade. Entry, Exit & Target for every position. How and what you are interested in buying based on your risk profile, psychological makeup, technical and/or fundamental data. Define your strategy before you invest and follow the strategy through to the end.
- Discipline – Know how to trade or don’t do it. Know how to enter your trades according to your strategy. Know how to exit your trades with the use of stops or alerts. Simply put know how to deal with the day to day process of trading your portfolio and each position within.
On Wednesday the S&P 500 index hit another new high closing at 1568. The risk is elevated relative to where we started and the fundamental data. No one knows when it will correct or what will cause the downfall, but we do know it will happen and we have to be prepared now for how to act when it does. This should be decided prior to the downside starting to remove the emotions from the process and to practice sound money management. Time horizon and amount of give back will determine the stop or exit point currently.
The ten sectors of that make up the S&P 500 index have seen solid moves to the upside, and likewise, are extended. Evaluate each and how they apply to your portfolio. Define your exit strategy and how to manage each position moving forward.
Risk management is the science of understanding how volatility will apply to the positions you hold and the current trend. In others words risk management is money management. Take the time to manage your money now, regardless of the outcome going forward.