There is one thing that Hugo strongly believes you must know as an investor. It’s the possibility the financial market gives to protect your investments. Especially when you think it is not necessary. Within this strategy, let’s look at some practical examples.
Building up your portfolio is probably the first thing you think of when we talk about investing. But maybe it is even more important to think about the protection of your money. The first moment an investor can think about the protection is when selecting the shares.
Not all the shares and other investments have the same risk profile, and the possibility of price movements of 10% in one day is not the same for all investments. But Hugo likes to think that it is good to realize that theoretically, all investments can go to 0. Each investor needs to decide for themselves if they accept this risk, or if they want to eliminate or reduce their risk.
Obviously, every investor likes the idea of eliminating or reducing your risk. The good thing about financial markets is that there are several ways to do so. A few possibilities to protect a (long) position:
You do need to take into account the consequences of protection. Are you willing to close all positions? Or do you want to hold your positions to maintain the potential and pay an extra premium for the protection? Alternatively, are you aiming for a period without any risk, but also without any potential?
The quality of the protection is another aspect to consider. If you use a stop-loss order you must realize that a position can be closed only if the markets are open. So the risk of an overnight event could result in a significantly worse price than you expected. Let’s further examine this. If you hold or buy share ABC with a price of 10, you could choose to add a stop loss at 9. Under normal circumstances, the risk to your portfolio is 10%. However, if share ABC closes at 9,20 and opens the next day at 8,50 the position can not be closed at 9. You have two options:
Other types of protection, like buying a put option and selling a CFD will actually cover the risk under the 9 euro.
For example, if you hold these 1.000 shares ABC (value in total 10.000 euros) and you buy the put option with the strike price of 10 euros, the value of the put option would be (at least) 1,50 euro if the share price of ABC is 8,50 euros. Now that is real protection! Obviously, this protection is not free, the price of the insurance for 1 year could be 1,00 euro per share. You still have the full potential of the share, so if the price of the share is 15 after one year, your profit per share is 4 (5-1), not bad!
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