Investment Basics

In order to be successful, there are a few basic guidelines that anyone engaged in financial investing should follow.

 

Taking risk

Embrace the fact that all security investing comes with some degree of risk, so make sure to choose the right risk-level for you and manage your emotions in regard to the risk.

 

All Investing Comes With Risk

One of the most basic concepts in financial investing is risk. Any and every security investment comes with some degree of risk, although the amount of risk varies. High risk comes with a high chance to win, but also high risk to lose.

People tend to forget that all investing comes with risk, even with investments that we think are safe, such as stock in large and established companies.

Let’s look at two examples from Sweden’s oldest and proudest companies:

If you bought B-shares of Atlas Copco on May 29th, 2015 (share price 257.8 SEK) and sold them on February 12th, 2016 (share price 181.0 SEK), you would have made a 30% loss on your investment in less than 9 months.

If you bought B-shares in Ericsson in February 2000 (share price 81.42 SEK after adjustments for splits and other things that skew price comparisons) and sold them in September 2002 (share price 24.8 SEK) you would have had a whopping 70% loss on your investment in less than 2.5 years’ time.

If you can’t accept, or you feel uncomfortable with, the fact that any and every security investment does come with some degree of risk, then don’t do it. Or at least make sure to implement the risk-lowering strategies discussed further down.

 

Cryptocurrency Investing is the Extreme Sport of Investmentbitcoin blockchain risk risk management

If cryptocurrency investing were a sport, then it would be Wing-suiting, the most extreme sport out there. Wing-suiting is the sport in which guys and gals jump off cliffs in body-suits that make them look like they have bat wings that make them glide through the air (but without a glider)! It’s an exciting experience, but the death-rate is so high that the sport is banned in most places.

Cryptocurrencies are right now the latest “Extreme Sport” in the world of investing with a high chance to win, but also a high risk of loss. Part of what makes cryptocurrency investing like an extreme sport is the high price volatility (price swings) and the fact that they are traded 24/7/365 (every minute of the year).

For example, if you bought Bitcoin on June 11th, 2017 (price 3,018.5 USD) and sold it on June 15th, 2017 (price 2,456.9 USD) you would have made a 19% loss in 4 days. And if you bought Ethereum on June 12th, 2017 (price 394.66 USD) and sold it on June 16th, 2017 (price 155.42 USD), you would have made a 61% loss in just 4 days!

 

If you’re able to handle high risk in your investments, then you might be able to handle cryptocurrency, but it’s advised to determine this before you get into it.

Ask yourself: Are you the type who can’t wait to put on a wing-suit, or do you call the people who do this sport crazzzy and prefer weekend soccer in the park? When you are out alpine skiing, are you the type that launches yourself into the steepest off-piste chutes, or the type who buys big bulky back-protection mostly to impress on the ladies during the Apres-ski? How does it make you feel to read that you can lose 61% of your money in just 4 days?

Both high-risk taker- and low-risk taker personality types are ok, good and needed in the world. But for your own well-being and sanity, determine which personality type you are and how well you handle high risk before you get yourself into a high-risk space such as cryptocurrency trading.

If you are not a true high-risk type person, don’t get into cryptocurrency trading, or just invest a very small part of your total funds in the space. If you are not comfortable with the amount of risk in the space, it will only make you sleep badly at night, create a lot of stress and is simply not worth it. If you still want to get into the space, at least make sure to use the risk-lowering techniques described below.

And if you are a high-risk person, embrace the fact that some of these people crash and burn. Too many wing-suiters meet a sad premature end to life, sometimes in many pieces in other people’s yards. Cryptocurrency investors could lose devastating amounts of money.

To quote Edward Moy, a professional investor and blogger for 15 years:

“If you don´t know who you are, the markets will tell you.”

 

Manage Your Emotions

If you assessed your personality type correctly and matched your risk-appetite to your investments, you shouldn’t have too much fear.

But there is always some fear involved, for example during a big price-dip. And as any high-risk taker person would tell you, it’s nerve wracking to take large risks! It’s crucial to not let your emotions of fear take over. In order to succeed, you must be able to keep your cool.

So how do you actually manage your emotions of fear?

First off, don’t take on more risk than you are comfortable with.

But there are also ways to minimize your fear of possible bad outcomes from the risks you take.

People who put themselves in the same risky situation over and over again eventually get over the fear of that particular situation.

The best example of this may be getting into a car. The one thing that is most likely to kill us (except old age and diseases) is getting into a car accident. So from a strictly rational point of view, we should all be terrified of getting into cars. Instead of cars, many people are far more fearful of spiders, well-groomed lap-dogs, the flu and other much less lethal things.

The thing is that it’s possible to get too comfortable with taking a particular type of risk if you continuously expose yourself to it, and that is why few people are terrified of cars. It is wise to be aware of this and not go too far with getting rid of your fears.

 

Finding Your Spending-limit

Don't spend more than you can afford to lose. Sounds obvious? Well, it is. Except… not quite.

The difficult part is to understand exactly what your ‘can’t afford to lose’ amount of money is. Most of us who were born in the West have many options when it comes to our personal finances. We can save or not save towards our retirement in low- or high-risk mutual funds, invest in higher education that will likely yield higher income in the future, take quick loans or use our credit cards to cover accidental over-spending; borrow from our houses/apartments that have risen in value etc. etc. We have a world of financial opportunities before us. So even if we lose some money investing, we have all kinds of financial solutions to potentially mitigate the pain of that loss.

Considering this, how do you determine exactly how much money is “what you can afford to lose”?

Try this. Make a rational calculation of how much money you think you can lose without damaging your overall financial goals (such as having X amount of money in retirement savings or having Y amount of monthly spending money).

Then do a thought exercise. Imagine yourself having lost all of that money and imagine how life would be after that.

Imagine yourself telling your spouse about it. How would that conversation go? Imagine making the adjustments with your bank to cover the losses. What interest rate would they be slamming you with? Imagine what things you would not be able to do if you lost the money, and how you would handle that. Would it be fewer meals out and more evenings alone cooking food?

Now, how did it feel when you did the thought exercise? Did it make you cringe thinking ofthat conversation with your spouse? Did it feel horrible to think about standing alone in your kitchen cooking food for lunch boxes instead of going out for drinks with your friends? If the answer to these questions is yes, then you need to lower the amount of money you estimated that you “can lose”.

On the other hand, if you went through the thought exercise feeling that it would be no biggie and that your life will go on anyway, then you’re good and your chosen amount of “can lose” is right for you.

Once you are actually investing, ask yourself again how you feel about the risks you are taking in your investment endeavors. Does it worry you when the market prices of your securities fall? If so, you need to lower your ‘can lose’ amount, or mitigate the risk in other ways. One of the first professional investors, Jesse Livermore born in 1877, famously said this about feeling uncomfortable about the amount of risk you are taking in the markets:

“Sell down to the sleeping point.”

 

What to invest in

This is one of the first things anyone learns when getting into investment, and the reason is simple. You can’t make a good investment decision if you don’t understand what you are making a decision about.

If you invest in Sandvik, you need to know their products (mining equipment, titanium, and furnace products) as well as the market for their products. In Sweden, many of the main companies listed on the Stockholm Nasdaq Stock Exchange are in heavy industry or the tech industry. This could be seen as unfortunate for anyone who is no whiz at heavy industry and tech related products and markets. The good news is that there are companies on Stock Exchanges all over the world that operate in all and every kind of business. Do you have a lot of knowledge about Computer Games? Then invest in Angler Gaming. Do you know stuff about Alpine Skiing? Then invest in Skistar. Marijuana? Invest in Aurora Cannabis.

If you invest in crypto currencies, you need to understand blockchain, decentralized ledgers and what SegWit actually means. Yes, the things you need to understand in order to get into crypto trading are very technical and not always easy to understand, which is another reason why investing in this segment is not for everyone.

If you choose to invest in anything, even though you don’t fully understand what you are investing in, be aware that you are then gambling and not investing. Is that what you want, to gamble? If yes, then go for it. If no, inform yourself so you make decisions based on knowledge about what you are investing in.

Warren Buffett, one of the world’s investment super-stars has a great tip for making sure you understand what you are investing in:

“Write down your reasons for investing in a particular stock -Because my bright neighbour said it’s a great investment- is not good enough reason to invest.”

 

Know and Accept your Knowledge Constraints

Even though we would like to be know-all super-minds, no one of us is, and that’s ok.

The most successful people anywhere are those who know and accept their knowledge constraints and who listen closely to others who know more than they do. Warren Buffet talks a lot about this, that he doesn’t understand everything and simply doesn’t invest in things he doesn’t understand. He has said:

“It’s a terrible mistake to think you have to have an opinion on everything. You don’t. Invest in what you have a rational opinion on.

 

How to Reduce the Risk

 

There are ways to diminish the level of risk in financial investing, other than the obvious, to stay away from investing in the first place.

 

Don’t Put all Eggs in the Same Basket

The classic ways to spread the risk is to ‘not put all eggs in the same basket’. By investing in different securities, the risk of the whole basket (in investing the basket is called portfolio) will decrease.

 

Buy Securities that Hold Different Amounts of Risk

Regardless of your personal risk tolerance, buy some low-risk securities, some medium-risk securities, and some high-risk securities (these are called different security classes). Then weight the different security classes according to your risk tolerance. 

Below are examples of low- and high-risk portfolios. By buying several securities in each risk-segment (3 with high risk, 3 with medium risk and 3 with low risk) you lower the overall risk of the portfolio. By using this technique it's possible to lower the risk even in high-risk portfolios, and by doing so you can reap the benefits of high-risk; the possibility to win big.

 

   

 

Buy several Securities in Each Security Class

Investors usually buy several securities in each class to allow one security to perform poorly without losing too much over all.

For instance, if you really believe in VR (Virtual Reality) and think that we will be able to use VR for all kinds of good things in the future, then buy a few different companies that develop VR applications. If one of the companies fail due to poor management decisions, running out of funds or another company specific reason, at least your other VR securities should do well and your overall loss will be much lower than had you invested in one VR company only.

 

Buy Cyclical and Counter-Cyclical Securities

Another popular way to diminish the portfolio risk is to invest both in cyclical and counter-cyclical securities. Some types of securities tend to decrease in price during recessions while others increase in value during recessions. If you buy both types of securities you won’t lose as much if a recession kicks in than you would have if you only buy securities that diminish in value during recessions.

A security type that generally does well in recessions is pharmaceuticals. People need their medicine no matter if it is a recession or not, and will buy it regardless. Typical recession-sensitive securities might be H&M and other fashion companies. When people lose their jobs in recessions they typically spend a lot less on fashionable clothes and instead use the ones they already have.

 

Buy at Different Points in Time

In the same way that investing in many different securities can lower the overall risk, so can buying the same security at several different points in time. If you do this, the chances that you unluckily bought your securities during a temporary high-peak are lower. Obviously, this also applies when selling securities.

 

Hold over a long period of time

The risk level is usually dramatically increased if you invest your money (buy and sell the securities) within a very short period of time, say 4 days, then if you are thinking to invest over a long period of time, say 10 years.

Take the Atlas Copco example from May 2015 (price 257.8 SEK) where you would have lost 30% had you bought at that time and sold the stock 9 months later. On the other hand, if you bought at the same time but instead held on to that same stock until June 22nd, 2017 (price, 339.8 SEK) you would have profited 31% on your investment. So, it usually (but not always) lowers the risk if you hold on to your securities for a long time rather than short time.

Still, it’s easier said than done to keep cool and not sell off a security when there is a big price dip. Many people have lost a lot of money because they sold off their securities in panic during big price collapses in the market, even if they intended to hold on to their funds for a long time. This leads us back to handling your emotions when investing and choosing the right risk-level for yourself.

2017-08-19

Disclaimer: The information in this article, as all content on BlockBull Review, is not and should not be seen as investment advice. The information is for educational and/or entertainment purposes only, so use it at your own risk. It is possible to lose money when engaging in any investment including cryptocurrencies and past performance does not indicate future performance. Any opinions expressed are those of BlockBull Review's writers who are not broker-dealers or advisors of any kind.


MORE REVIEWS

October 10, 2017

The Top Altcoins – Ether, Ripple, Litecoin

We have compared the three top altcoins in 2017 - ether, Ripple and litecoin. We have looked at what their purpose is, pros/cons, market cap etc.
December 17, 2017

The Best Hardware Wallets in 2018

A full comparison of the best hardware wallets in 2018. How they protect your cryptocurrencies, their user-friendliness, price etc. And what are these things anyway?
July 28, 2017
Crypto Currency Credit Cards

The 6 Best Bitcoin Debit Cards

There are several Bitcoin debit cards to choose from, and the fees and services vary quite a lot. We have compared the best 6 Bitcoin debit cards available for people who live in Sweden.

LEARN THE BASICS

September 19, 2017

New Technology Will Change Banking

New technology has shaken and fundamentally changed many industries including the music industry, the media industry, and the retail industry. Many now believe it's banking's turn. Bitcoin is well positioned to win the race, but there are other possible paths of development.
August 30, 2017

How to Reduce Risk

There are many ways to reduce the risk in your investments. We go through the most common and effective ways you can use to reduce the risk to your comfort level.
September 1, 2017

Security Basics

The fintech space is not fully developed yet, nor is the security around it. When investing in crypto currencies one must take extra precaution, we discuss how.
Share