Understanding Investment Risks

Investing is all about one thing: dealing with the future. No one can predict the future with certainty, so risks are inevitable. Managing risks is a fundamental element in investing.

1. Understanding Risks

Risk is the probability of permanent loss. The risk of loss is mainly attributed to an overly optimistic psychology, which leads to excessively high prices. The risk of loss is the risk that people care about most when they demand expected returns and set investment prices. Risk implies that there are more possible events than certain events. The key to understanding risk is that risk is largely a matter of personal perspective. Even after the event occurs, it is difficult to have a clear understanding of the risk.

To be fair, I believe that investment performance is the result of a series of events - geopolitical, macroeconomic, corporate, technological, psychological - colliding with the current investment portfolio. The future has many possibilities, but there is only one outcome. Returns themselves - especially short-term returns - cannot indicate the quality of investment decisions. Investment risks are largely invisible beforehand - except for those with extraordinary insight.

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Most importantly, most people view risk-taking as a way to make money. Taking on higher risks usually leads to higher returns. The market must somehow prove that this is the case. Otherwise, people would not engage in high-risk investments. However, the market cannot operate in this way forever, otherwise, the risk of high-risk investments would cease to exist. Once risk-taking does not work, it does not work at all, and it is only then that people will remember what risk is really about.

2. Identifying Risks

Risk means the uncertainty of the upcoming results and the uncertainty of the probability of loss when adverse outcomes occur.High risk is mainly associated with high prices. Ignoring the risk and rushing in at high prices is one of the main sources of risk. The belief that risk has disappeared is one of the most dangerous sources and is also a major factor in promoting bubbles. When the market swings to its highest point, the belief that the risk is low and the belief that investment will definitely make a profit make people excited, so that they lose the due vigilance, worry and fear of loss, and only worry about the risk of missing the opportunity.

The market is not a static place for investors to operate, it is controlled and influenced by the investors' own behavior. Increasing confidence should bring more worry, just like increasing fear and risk aversion, which reduces risk while increasing risk premium. This phenomenon is called "the anomaly of risk".

The greatest investment risk lies in the place that is least noticeable. When everyone believes that something is risky, their unwillingness to buy usually reduces the price to a point where there is no risk at all. Extensive negative opinions can minimize risk, because all optimistic factors in the price are eliminated.

When everyone believes that something has no risk, the price is usually raised to a point where there is a huge risk.

3. Control risk

Outstanding investors are outstanding because they have the same outstanding risk control ability as the ability to create returns.

The past unfavorable environment does not mean that risk control is not needed, even if the results show that risk control was not necessary at the time. It is important to realize that even if there is no loss, risk may still exist. Therefore, no loss does not necessarily mean that the investment portfolio is safe. Risk control is invisible during the prosperous period, but it is still essential, because the transition from prosperity to decline is easy.

When the market is stable or rising, we have no way of knowing how much risk there is in the investment portfolio. This is what Warren Buffett observed, that unless the tide goes out, we can't tell who is wearing clothes and who is swimming naked.

Risk control is the best way to avoid losses, on the contrary, risk aversion may avoid both losses and returns.

Should a stock that has lost 30% be replenished to reduce the cost?If you bought a stock and it lost 30%, how much does it need to rise to break even? The answer is not 30%, but 42.8%. For example, if you bought a stock at 10 yuan and it fell by 30%, the stock price dropped to 7 yuan. If the stock price then rose by 30%, it would only reach 9.1 yuan, and you would still be down 9%. The stock price needs to rise by 42.8% for you to break even. Because the base changes, the deeper you are trapped, the more difficult it is to break free. If you are trapped by 50%, then you need a 100% increase to break even, let alone make a profit.

Therefore, after a stock has lost 30%, if you want to break even as soon as possible, you do need to add to your position. However, there is an important issue here: if the stock continues to fall after adding to the position, not only can you not break even, but you will also lose more. Whether to add to the position or not, you should first determine the trend. Looking back at many stocks in 2015, the decline is now more than 90%.

Let's make an assumption: the original price is 100 yuan, you bought 1,000 shares, which is 100,000 yuan. When it fell by 30% to 70 yuan, you added 1,000 shares and added 70,000 yuan. At this time, you have invested a total of 170,000 yuan, holding a total of 2,000 shares. Now, if it has fallen by 90%, the stock price has dropped to 10 yuan, and your 2,000 shares are now definitely 20,000 yuan. That is to say, after the 30% drop, if you double the position and hold it now, you have lost a total of 88.3%. So, do you think you need to add to the position?

Therefore, this is actually an open question with no standard answer.

There are three common position management methods in the stock market:

1. "Funnel" position management method

This position management method requires a relatively small initial entry capital, with a light position. If the market moves in the opposite direction, gradually add to the position in the later market, thereby reducing the cost, and the ratio of adding to the position becomes larger and larger; it is precisely because the initial risk is relatively small, and the cost is spread quickly, the higher the funnel, the more considerable the profit will be; its main risk is: once the direction is judged incorrectly, it will lead to an inability to profit, and later as the position becomes heavier, it will lead to capital turnover difficulties. (Suitable for trend traders)

2. "Rectangular" position management method

This position management method requires that the initial entry capital accounts for a fixed proportion of the total capital each time. If the market develops in the opposite direction, gradually add to the position later to reduce the cost, and follow this fixed ratio when adding to the position; average the risk and manage it in an average way. Under the condition that the position can be controlled and the future market direction is consistent with the judgment, there will be substantial profits. The main risk comes from: the cost is spread more and more slowly, and it is easy to fall into a trapped situation. (Suitable for conservative investors)3. "Triangle" Position Management Method

This position management method requires a relatively large initial capital investment. If the market moves in the opposite direction afterwards, no additional positions are added. If the direction is consistent, positions are gradually added with the proportion of each addition becoming smaller and smaller. Position control is carried out according to the rate of return, with higher win rates leading to higher position utilization. The method leverages the continuity of trends to increase positions. During the trend, high returns can be achieved with a relatively low risk rate. The main risk comes from: the initial position is relatively heavy, and the requirements for the first entry are relatively high. (Suitable for high-tech speculators)

A complete trade consists of four major elements: entry, exit, addition, and reduction. Entry and exit points are determined through trading strategies, and position management is used for adding or reducing positions. The two complement each other and are indispensable. If there is a feeling of earning less when the stock price rises quickly; after the stock price rises and then corrects, there is a feeling that more could have been earned; it is likely that there is a problem with position management, such as unreasonable position establishment or failure to adjust the position in time. Therefore, good position management plays an important role in a successful trade.

Position management is based on the foundation of trading strategies and cannot rely on a single method to be effective in all situations. We roughly divide trading strategies into two categories: left-side trading and right-side trading. How to distinguish between them?

Science Popularization Time: Position Management!

As the name suggests, position management is the reasonable control of one's own positions. The terms we often use, such as light position, heavy position, full position, and empty position, are all expressions of position, reflecting different attitudes towards position management. Generally speaking, effective position management may neither increase our returns nor reduce our losses, but it can control our investment risks, allowing you to reasonably control your holding costs in times of crisis.

The quality of position control will directly affect several important aspects of investors:(1) Most importantly, the position will affect the investor's attitude towards the market, thereby causing bias in their analysis and judgment.

(2) Position control will affect the investor's risk control ability.

(3) The quality of position control determines whether investors can profit stably and continuously from the stock market in the long term.

(4) The weight of the position also affects the investor's mentality, and a heavier position can make people anxious and irritable.

Position control is so important, but many investors, especially small and medium investors, often have problems in this aspect.

In simple terms, investors are prone to the following three problems in position control:

(1) Some investors also know that keeping some cash is flexible, but in the process of operation, they keep replenishing the position, and the more they replenish, the more trapped they become, and finally become full position. The reason is that there is no good fund management plan. In different market conditions, if the ratio of cash to stocks has been determined in advance, it should be strictly implemented according to the plan.

(2) Some investors can achieve a reasonable allocation of cash and stocks, but often have some problems in the combination of varieties.

For example, being too concentrated in a certain sector, which increases the risk of investment.

(3) Many investors often go full position after determining the stock. This approach is actually very gambling, and once an unexpected situation occurs, the loss is self-evident.In order to enhance the likelihood of successful investment, investors must properly manage their positions and avoid falling into the pitfalls of position control.

For investors, to effectively control their positions, they must be targeted and adopt different control measures according to different criteria.

Scientific position-building and exiting behaviors can largely avoid many risks, minimizing the risk coefficient of capital investment. Generally speaking, the behavior of building positions is divided into three main capital investment methods: simple investment model, compound investment model, and portfolio capital investment model.

The specific usage methods of the three models are as follows:

1. Simple Investment Model

The simple investment model is generally a 50-50 allocation, meaning that the capital investment is always half of the position. It maintains the necessary and maximum vigilance for any market conditions, always adhering to half-position behavior. For the risk investment in the stock market, the first step is to strive to be invincible, always maintaining the active right to use funds. In the event of a loss in the investment, if a position-adding action is needed, the investment behavior of the reserved funds is also a 50-50 allocation, rather than a one-time position-adding. The 50-50 allocation is the basic model of the simple investment method, simple but with a certain degree of safety and reliability. However, the disadvantage of the 50-50 system is that the investment behavior lacks some proactivity.

2. Compound Investment Model

The investment method of the compound investment model is more complex, strictly speaking, there are multiple levels of division, but mainly there are the three-part system and the six-part system.

1. The three-part system mainly divides the funds into three equal parts, and the position-building behavior is always completed in three steps, gradually entering. For large funds, the position-building behavior is a certain area judged, so the position-building behavior is a periodic behavior. The position-building behavior of the three-part system generally also retains one-third of the risk funds. Compared with the two-part system, the position-building behavior of the three-part system is more active. When two-thirds of the funds invested in the three-part system have been completed and a certain profit has been obtained, the remaining one-third of the funds can have a more active investment attitude. The investment model of the three-part system is not complicated, more scientific than the two-part system, and more proactive in investment attitude than the two-part system. However, this active position-building behavior must be based on the premise that the main body of the investment funds has obtained a certain profit. The disadvantage of the three-part system is that the risk control is relatively lower than the risk control ability of the two-part system.

2. The six-part system is relatively a combination of the basic characteristics of the two-part system and the three-part system, actively playing the advantages of both models. The specific capital division of the position-building behavior of the six-part system is as follows: The six-part system divides the total investment funds into six equal parts, and the six parts of the funds are divided into three steps. A. The first step is 1 unit, accounting for 1/6 of the total funds, B. The second step accounts for 2 units, accounting for 1/3 of the total funds, C. The first step is 3 units, accounting for 1/2 of the total funds.The six-point system for establishing a position is relatively flexible and represents an effective combination of capital across three tiers: A, B, and C. Depending on market conditions, capital can be allocated using six different combinations: (A, B, C), (A, C, B), (B, A, C), (B, C, A), (C, A, B), and (C, B, A). Regardless of the combination used, the last group is always the risk capital. Moreover, regardless of the tier, the introduction of capital must be progressive for each unit. While using the A, B, and C tiered capital, you can also use a binary system for the B tier and a ternary system for the C tier, making the approach more comprehensive. The six-point system is a flexible, mobile, and secure investment model that combines the advantages of the two methods mentioned above, but its drawback is the complexity of the procedures during use.

III. Portfolio Investment Model

The portfolio investment model is not exactly the same as the perspective discussed earlier. Strictly speaking, it is not divided by the amount of capital, but by the investment cycle behavior to determine the division of capital. It is mainly divided into three types of investment models: long, medium, and short cycles to decide the division of capital. Generally, the total capital is now divided into four parts: long, medium, and short-term capital, as well as risk control capital.

From the above, we can see that the division of each type of capital and the position-building model should be multi-angled. Therefore, the position-building behavior is based on the executor's accurate judgment. However, scientific position-building behavior can better control the decision-maker's decision-making risks. Thus, the decision-making of the decision-making layer and scientific position-building behavior are inseparable.

What is the reason for your failure?

1. To break through oneself

This is like arriving at the airport, but watching the plane take off. Wouldn't it be great if you could catch the plane and arrive at an exciting destination?

The market is full of distractions. How to maintain attention as straight and clear as a radar? How to be free from unnecessary interference?

3. Want to invest correctly, but do not want to make a profitIn almost all trading rooms around the world, there are always people running around to announce to their colleagues that they know the high and low prices of almost all market trends. Yet, they have never made a profit.

4. Lack of Consistent Use of Trading Systems

In the stock market, many investors lack a consistent use of trading systems during the operation process, which leads to repeated failures in the trading process, and finally ends up with losses.

In fact, if the majority of investors could skillfully operate and consistently use a trading system during the operation process, they would be able to make progress and gain profits.

5. Lack of a Clearly Defined Capital Management Plan

In the stock market, there are always some investors who neglect the management of capital, leading to a messy and unreasonable capital management, and finally being greatly frustrated in the stock market.

In fact, if the majority of investors could learn more about capital management knowledge to help themselves manage capital well, they would be able to make a profit.