Risk management is a topic that is too often neglected in financial media and by market participants. The focus is almost always on breaking news, trade setups, and speculation as to what markets will do next. However, the reality is that without risk management none of that other stuff matters.
The last two years have seen a surreal rollercoaster of market swings, investor sentiment, and unprecedented events (both in markets and in geopolitics). Never before has it been so easy to open a trading account and buy a stock at the touch of a finger, and never before have so many market novices embraced taking risk in financial markets.
“Risk comes from not knowing what you're doing"
Bitcoin’s remarkable ascent from an essentially worthless digital token in 2009 to being worth more than $60,000 at its peak last year stoked many people’s imaginations as to what is possible through investing. Along with Bitcoin and cryptocurrency came the concept of “HODLing”. HODL is a term that was coined during one of Bitcoin’s big crashes in late 2012, and basically means "to hold and never sell". Long term passive investing in the stock market is nothing new, and it has been proven that simply buying the S&P 500 index and holding it over time and through market corrections outperforms the vast majority of active hedge fund managers.
However, it is important to note that buying an index of 500 large cap stocks with retirement funds and a multi-decade time horizon is much different from putting all of one's money into a cryptocurrency that doesn’t pay dividends or even have any intrinsic value.
This is where risk management comes into play. An entire generation of new investors have learned that taking maximum risk is a good thing, and reducing drawdowns is for “paper hands”. The reality is that nothing could be more detrimental to one's longevity and success as an investor.
In a world in which unprecedented events seem to be occurring with increasing regularity, it is more important than ever for market participants to focus on risk management. Without a robust risk management discipline we are increasingly vulnerable to market instability.
"Unprecedented events occur with some regularity, so be prepared."
So let’s talk about risk management and some concepts that have served me over the years. The following set of ‘rules’ and principles have helped to keep me in the game during some epic market meltdowns in the last twenty years:
"The problem in investing, I think, is timing. You may be right. But in the long run, we're all dead. Even if you're right, if it takes 20 years to work out, it can be a disaster."
"Humility is an enormously important quality. You can’t win without it. Survival in the end is where the winners are by definition, and survival begins with humility."
Another key aspect of effective risk management is being cognizant of the overall market environment. There are times when taking on more risk is warranted due to the strength of overall market trends, or a unique opportunity in a particular trade thesis/setup. However, there are also times when market conditions are generally unfavorable and the trader is better served by reducing one's overall risk and market activity. Technical analysis can help us to more clearly see the bigger picture while managing risk and avoiding some of the biggest pitfalls.
One of the simplest ways to determine if the market environment is favorable or unfavorable is the positioning and slope of the 50-day and 200-day SMAs. When price is above the 50/200 SMAs and they are sloping higher, the market environment is generally more favorable and trade setups are likely to be more abundant. However, when price is below downward sloping 50/200 SMAs, like the situation we find ourselves in today, the environment is less favorable for most trading styles and overall market risk should be reduced:
Sometimes stepping away can prove to be the strongest decision. The market will always be there when you choose to return.
The work included in this article is based on current events, technical charts, company news releases, and the author’s opinions. It may contain errors, and you shouldn’t make any investment decision based solely on what you read here. This publication contains forward-looking statements, including but not limited to comments regarding predictions and projections. Forward-looking statements address future events and conditions and therefore involve inherent risks and uncertainties. Actual results may differ materially from those currently anticipated in such statements. This publication is provided for informational and entertainment purposes only and is not a recommendation to buy or sell any security. Always thoroughly do your own due diligence and talk to a licensed investment adviser prior to making any investment decisions. Junior resource and biotechnology companies can easily lose 100% of their value so read company profiles on www.SEDAR.com for important risk disclosures. It’s your money and your responsibility.