Discover an effective way to manage your risk when you buy stocks

Fsp Invest Team, 03 May. 2013

Tags: position size, invest, shares, risk management, portfolio management

The risk of losing money when you invest is inevitable. But knowing how to manage your risk can make you a profitable investor. Here’s one method you can use to better manage your risk and protect your money when buying stocks.

“When you first decide to start investing in shares it’s exciting. When shares go up, as an investor, there’s no better feeling. But the shares you’ve bought with your hard earned cash can go down as well. You might lose a little or you might lose a lot. But always remember this: you can lose,” says Francois Joubert, Chief Investment Strategist behind The Resource And Scarcity Report.
Luckily, there’s a way to manage the risk of losing money when you invest.

Here’s what to do to manage your risk when buying stocks

“If you're planning to invest, you need to know whether you are prepared to risk a large, medium or a very small proportion of your money to invest. You should ensure that you only invest what you can afford to lose,” says

To manage your risk as an investor, you need to determine exactly how much you should invest and set your position size. It’s advisable that you set a small position size to ensure you stretch your capital further.

“A general rule of responsible investing and good risk management is that you should never invest more than 5% of your portfolio in any single share,” says Joubert.

“Say you’ve put aside R100,000 for trading the stock market. You’ve found a stock you want to buy. If you allocate 5% of your total share market portfolio to this new share it means you’re investing R5,000 (R100,000 X 0.05). This could mean you’ve bought 5,000 R1 shares, or 50 R100 shares, or even 10,000 50c shares. The share price doesn’t matter, what matters is that you’ve taken a position in the stock,” explains Joubert.

So if you spend 5% of your money on one position, it simply means you can invest in 19 more stocks before you’ve allocated all R100,000 of your available funds. But if you spend 10% of your money to take a position on this share, it’ll mean you R10,000 in every position. By allocating 10% of your money to one position, you’ll be left with just enough money to invest in nine positions, if you’re spending 10% of your money on each new share.

By using a smaller position size of 5%, it means you can stretch your capital. But, Joubert warns that even though this isn’t a comprehensive theory on portfolio management, you should never put too much money in one position.

Here’s an example of how smaller position sizes make losses more manageable

Cash available: R100,000
Example Value Loss (%) loss Actual Loss as a % of your portfolio
5% in each stock R5,000 40% R2,000 2%
10% in each stock R10,000 40% R4,000 4%
50% in each stock R50,000 40% R20,000 20%
Based on the above example, the larger the position size, the bigger the hit your portfolio will take if things go wrong and the more money you’ll lose.

By knowing and applying this risk management method, you can be a profitable investor and minimise losses when investing.

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