What are the risks of investing your capital in the markets?

 

  • Systematic Risk (Market/Undiversifiable Risk) – Affects global economy and large amount of assets – Large economy-wide problem – Macro – Volatility (CashFlo® Concept See Bottom)

    • i.e. 2008 housing bubble burst, 9/11 terrorist attack, Recession, Brexit

  • Unsystematic Risk (Diversifiable risk) – Affects small amount of assets – firm specific risk - Micro

    • i.e company missed earnings estimate, demand/supply estimate errors

  • Liquidity Risk – Risk business will be unable to make short-term financial demands and/or individual investor needs immediate cash and cannot trade or sell at market value due to a lack of buyers

  • Financial Risk – Risk shareholders lose money when company takes on debt with inadequate cash flows – Creditors get paid back first before shareholders

    • Default Risk – Risk company will default on debt obligations (Bankruptcy)

    • Capital Structure Risk - Does company use debt or equity to raise funds for operations?

      • Equity financing – issuing stock to raise capital for operations
        • Dilution
      • Debt financing – selling bond, bills, or notes to creditors for principle + interest repayment to raise capital for operations – leverage
        • Toxic debt – debt that has a low chance of being repaid with interest

  • Political Risk – Risk of political/government changes or instability in a country

        • i.e. change in government, legislation, foreign policy

  • Foreign-Exchange Risk – Risk an investment value changes in currency exchange rates - Macro

        • i.e. China currency devaluation, currency crisis, strong/weak USD$

 

Why would I take on so much risk?

 

  • Accepting, or being tolerant of these risks, is the only way to make substantial returns in the market and achieve CashFlo® Financial Freedom.

    • “Scared money does not make money”
    • Being risk-adverse, or not willing to take on risk, still puts you at the risk of:
      • Being trapped in low-performing financial plan
      • Most financial plans under-perform the market benchmark
      • Not receiving adequate returns to contribute to your financial success
        • i.e. the risk-free rate of treasury 3-month bills (usually <1%)
      • Being taken advantage of by financial advisers and fees
      • The market rate of return – recessions, corrections, volatility
      • Missing valuable stock market opportunities throughout your life that can be easily recognized – opportunity costs

 

How can I use risk to my advantage?

 

  • You can capitalize on these individual risks by learning and recognizing how these risks affect market prices.

    • An increase of one of these risks can correlate to a decrease in market value and vice versa.

  • Recognizing when to take profit or move to cash during volatile spurts or corrections in the market.

    • A stock/index/commodity/currency almost always undergoes a short-term correction or pullback in price after a large rally
      • This is usually caused by profit-taking, market makers, and fundamentals.

 

Is it possible to make money on the downside of a market/stock/index?

 

  • Yes, through utilizing Volatility ETFs, Inverse ETFs, or Short Selling.

 

 

What tools can I use to minimize risk in order to maximize profit?

 

  • The market will take your money if you do not fully understand these risks outlined above or use proper risk minimizing strategies. Here are our favorite risk management tools:

    • Technical Analysis – Support/resistance chart technical signals based on historical price action and patterns.

      • Candlestick Patterns
      • Price Level Support/Resistance
      • Moving Average Support/Resistance
      • Volume Indicators
        • Bid/Ask Level 2 Support/Resistance
      • RSI (14) – Relative Strength Index - momentum indicator measuring the speed and change of price movements. RSI moves between zero and 100.
        • RSI > 65 = overbought and will likely pullback/correct
        • RSI < 35 = oversold and will likely bottom/bounce

    • Investment Entries and Exits—when to enter or exit a trade using technical targets and catalysts.

    • Position Sizing – Never enter a trade with your entire capital. Buy in with a mindset you are willing to lose that money.

      • “Averaging Down” – Reducing your average position price. For example, let’s say you enter a trade after your first price support target is hit at $5.40/share, thus your investment position price is now $5.40/share. The price then goes lower and hits your second support price target at $5.00/share. Here you should buy the same quantity of the stock in order to reduce your average position price to $5.20.
      • “Averaging down” should only be used on chart setups, patterns, and correlations of which you are fairly confident a bounce (or pullback for short selling) is imminent.

    • Limit Orders – All brokerages have the option to set limit orders—orders that will be triggered to buy/sell at a given price. This allows you to place an order at an entry/exit you are comfortable with and not just the at the current market price or market order.

      • Stop loss limits are crucial to trading success. This limit order allows you to set a price limit where you want to sell.
      • Stop loss orders 3-5% below your entry is ideal. This allows you to cut losses quickly when you are wrong. We cannot stress enough how important this is for beginning traders as beginning traders are prone to be overly confident with trades - We have been there!

 

 

CashFlo® Tips:

 

  • Never be “married” to a position where you are waiting/hoping for a stock to move upward or downward.

  • Stop loss limit orders can be also be used to take profit when you are making money on a trade by trailing it along as price action moves in your favor.

 

CashFlo® Concepts:

 

  • Volatility – the amount of uncertainty about that size of changes in a securities value

    • This is a very important CashFlo topic we will discuss more in-depth as you progress, such as:
      • How to make money during volatile time periods by investing into the volatility index (VIX) or related ETFs.
      • Most downward price action is driven by fear not fundamentals.
      • Determining volatility spikes to determine market shifts from a Bull to Bear market or vice versa

  • Dilution – the dilution of outstanding common stock share structure by:

    • Issuance of more shares
    • Company employees exercise their stock options
    • Convertible debt converted into common stock

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