How to Protect Yourself While Trading

Avoid the temptation to treat the stock market like a high-stakes poker game and don’t put all your chips into a single hand. For instance, maybe you do some research and find that a particularly great stock deal is coming up soon. Perhaps a company’s shares are super low by you believe that they’re about to skyrocket in price.

As tempting as it might be, do not commit all of your cash to a single trade. This could work out immeasurably well, but it could also end up tanking your portfolio and removing your ability to invest in the stock market for some time to come. 

This is true even if you have plenty of experience under your belt. In fact, experienced stock traders would be the first to tell you that putting all your proverbial eggs into a single basket is foolhardy at best. Instead, remember to keep a diverse portfolio and buy shares with set amounts of cash.

This has a side effect of making you a little less emotional whenever you buy or sell. More often than not, this is one of the better trading strategies.

Similarly, avoid emotional buying or selling in response to news events or other ambient “market noise”. Market noise, in this sense, could be any kind of communication or general hubbub you hear about asset movements or price changes.

Avoid thinking like another part of the crowd. Think for yourself.

While looking at the news and keeping abreast of events that could affect your portfolio and future buying decisions is important, don’t have a knee-jerk reaction and, for instance, sell all of the shares for your favorite company just because they have a bad quarter.

Similarly, don’t necessarily jump on the bandwagon when a news article comes out about an awesome startup tech company that might have the cure for cancer. Do a lot of research and make measured, critical purchases or sales depending on what you learn and what works best for your long-term investment goals.

The truth is, most people are average at trading on the stock market, just as most people are average at everything in the world. Just because most people are buying or selling a particular asset doesn’t mean that it’s a necessarily smart idea, even though it may seem so because of peer pressure.

We mentioned this a little earlier, but in a nutshell, a diverse portfolio is one with a variety of stocks, options, and other assets under its umbrella. It’s not a portfolio only made up of real estate investments, staple crop stocks, tech options, etc.

Holding a diverse portfolio is a great way to protect yourself while trading because:

• ☑️ it insulates you if one or more key stocks or assets start to fall in price

• ☑️ it protects in the event of an entire industry going under

☑️ it protects you from stock overvaluation

For instance, say that you had all of your stocks in real estate companies and similar ventures. This sounds like a solid strategy, right? After all, isn’t real estate the best investment market to get into for its stability?

As 2008 showed us, this is not always the truth. Those who had their portfolio dedicated to real estate investment saw sharp losses as the housing bubble popped. If they’d had a diverse portfolio, they would’ve lost, yes… but not everything. In a nutshell, a diverse portfolio allows you to survive hurdles that more specialized investors often stumble on. 

This is particularly important when it comes to stocks. United States stocks are extremely valuable these days, so everyone tries to get a piece of the S&P 500 (a collection of the most valuable publicly traded companies in the economy at this moment).

But perhaps because US stocks are so valued, they’re also a little bit overvalued, as any experienced stock market risk analyst will tell you.

US stocks are performing well right now, but what comes up must come down. This doesn’t necessarily mean a big recession or depression is on the way, but it does mean that your stock portfolio should be more diverse if you only have US assets at this time.

Look into foreign stocks if you can. These are starting to tick up significantly, particularly in developing countries and in Europe.

This strategy is related to holding a diverse portfolio in general. “Non-correlating” assets are simply bonds, currencies, commodities, stocks, and everything else that are not related to one another. Basically, it means you should have multiple types of assets in your portfolio instead of just a bunch of diverse stocks.

This is because different assets on the stock market react differently to market change. For instance, stocks across the market could fall over a short timeframe, but bonds or other assets might go up.

If you have a portfolio diversified both in the types of things you invest in and the assets you hold, you’ll be insulated from practically any type of market failure short of a full-on depression like we saw in 1929.

This does mean that a portfolio with non-correlating assets won’t necessarily have as many gains as a fully specialized portfolio riding a special wave of certain successful stocks, options, or the like. In this way, a more balanced portfolio forgoes the super high wins in favor of protection from really bad losses.

Conventional (and time-tested) wisdom says that you should usually hold onto stocks that are doing well. In general, and even when accounting for historical dips like the Great Depression or Recession, the stock market goes up and stocks increase in value.

But you might want to lock in some gains without getting rid of all your winning stocks fully. This way, you can lock in your profits without eliminating the opportunity for greater profits in the future. What do you do?

Buy put options. In brief, these are trades where you bet that the stock attached to the option will decrease in price will become less valuable. When you buy a put option, you can sell at that price later down the road.

Here’s an example:

• ☑️ You own 50 shares for A Company. It trades at $100

• ☑️ You believe that the value of these stocks will decrease shortly before generally rising over the long-term

• ☑️ You buy a put option for A Company for six months in the future. The strike price for this option is $105

• ☑️ Meanwhile, it costs $5 per share to buy the same option

• ☑️ This entire set up means you are able to sell 50 shares for A Company at $105 a share before the option expires

☑️ If, for example, the price for A Company’s stocks go down to $90, you can sell the option and make a profit to offset your losses from the lower stock price

Put options are great ways to shore up your investments and cushion yourself as eventual but temporary decreases in stock value roll around from time to time. The strategy is a little more complex than this basic overview, and there’s a lot to knowing what a good put option looks like, but that’s the gist.

If you have a good stock trading app or platform, you should become familiar with its stop-loss order functionality.

A stop-loss order is an automated command that tells your portfolio (or whoever is running it) to sell a particular share or another asset in the event that it reaches a certain low price. It’s essentially in order to cut your losses and escape with as little loss as possible.

There are two main types of stop-loss orders: hard stops and trailing stops. Hard stops are the easiest to understand. Set a hard stop for, say, $10 and the automated command will sell the attached shares if they ever drop to that value. This prevents you from taking more of a loss if the shares continue to drop in price.

A trailing stock moves with the stock price and is based on percentages. You can, for instance, set a trailing stop for 10%. This allows you to sell based on relative value and adjust more agilely with the market. Either way can work, but everyone should utilize these orders to protect their portfolios from losses you can’t recover from.

This little-known strategy is perfect for those who want to keep their principal investment costs intact as they trade.

Principal protected notes are very similar to bonds in that they are securities objects that return your principal investment to your account if you hold the principal-protected notes until they mature.

You can use principal-protected notes with “equity participation” rights as well. You can purchase these notes with certain participation rates, which entitle you to some share of the profits upon securities maturity.

For instance, if you have a principal-protected note with an equity participation rate of 90%, you’ll get your original investment plus 90% of the profits made over the trade term.

Therefore, these are excellent purchases if you are a risk-averse trader and want to protect yourself in a fickle or uncertain market environment.

One last way to protect yourself while trading is investing in dividend-paying stocks. This isn’t necessarily because of the stocks themselves, but because such objects are usually only offered by stable, profitable companies. It’s a little circular, but essentially:

• ☑️ Companies that do well offer dividend-paying stocks…

• ☑️ Companies that pay out dividends get more investment and do better…

☑️ So they offer more dividend-paying stocks and everyone makes more money.

Essentially, these stocks can increase your overall return on investment. You get not only the value from the stocks as the attached company becomes more valuable, but you also get the dividends from those stocks (which can be distributed quarterly or yearly).

In another way, this connects you to a company’s success in a way that few other stock market assets can. Making more money protects you while trading since you have more cash to fall back on during hard times.

In the end, learning how to buy and sell on the stock market capably, and figuring out the optimal portfolio building strategies for your investment goals, is a long-term effort. You won’t ever be perfectly safe on the stock market, but you’ll eventually become safer and see better returns on your investments the more you practice.

Follow the above tips to protect yourself during the beginning of your stock market journey and you’ll be more likely to see great success!

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