Why investing is a financial safety net

Investing is a serious matter

Investing is not only profitable but also risky. Are you scared of it? If you are, you are doing everything right! We have seen how it can eat up capital when trading with leverage as exemplified by the Canadian dollar with a gap from 1.34232 to 1.35466.

Just imagine that going short with a short stop loss of 20 pips results in a 120-pip loss. In cases like this, your position will simply be closed at the price of the gap, which is six stop losses, mind you. All risk management goes down the drain.

Moreover, an unpleasant surprise awaits those who prefer middle-term trading or believe that the gap should be closed here. More often than not, gaps tend to close anytime and anywhere. Without a proper risk management system, this is a very questionable approach.

That being said, Canadian dollar situation described above is still manageable, as compared to the surprise that awaited oil traders with a 30-percent drop. In other words, even the third leverage would require additional capital investment, whereas with the fourth leverage you would have to let go of the deposit.

But as we know, nothing ventured, nothing gained. It’s all about the balance and not going into extremes.

Investing is not only about the risks, but also about profit. Holding onto money when there are no apparent risks means feeding the inflation which can ramp up as a result of massive injections into the economy by the central banks, be it the U.S. dollar, the Swiss franc or the Norwegian krone.

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Investing: opportunities or risks?

In no way am I trying to discourage you from speculative trading by providing the above examples. These situations happen quite rarely, and you can trade smoothly for several years.

However, you should keep in mind that at some point these situations may turn out to be disastrous. So, you need to be able to protect yourself against the so-called black swans, at least by having a certain portion of portfolios where you don’t risk the entire capital, but profitability from investment activities.

What does investing mean? Typically, people believe that it is all about buying and keeping stocks, preferably dividend-paying ones. But here is an example of the Japanese stock market (Fig. 3), or the Spanish stock market, the good time of which fell on the early 2000s (Fig. 4).

Or the highly-dividend ExxonMobile with a rate above 5% that plummeted over -60%. Due to this, the capital, which could have been used a lot more efficiently, had been frozen for a long time.

There will be those who are going to recommend diversifying stocks and bonds. Still, if you take a look at the chart, volatility can skyrocket here. This is what happened in 2007, having restrained the capital for quite some time. For a profit of several percent, you get a 22% drawdown all because you entered the market at a wrong time.

Today’s situation is quite likely to develop similarly, forcing the markets to return to their regular correlation element. Meanwhile, there are definitely those who have already fallen victim to an unlucky accumulation at 180 in TLT.

Stocks and bonds can indeed often move in different directions and maintain a similar correlation for a long time. Yet the black swan of correlation (e.g. in the form of inflation escalation) can badly affect a poorly-built portfolio of stocks and bonds pretty hard.

This is why, in my reviews I often talk about the key points of capital movement, correlation links, as well as foundation i.e. indices and stocks, bonds, raw materials and gold. There are also currency market instruments that can be a solid diversification option.

You can learn more about investment diversification by watching my webinar below.

Investment requires comprehensive approach

Risk management and a careful attention to the violation of correlations give us a clue about the capital movement. It should be noted that we do not know exactly where the “biggies” channel their capital.

And by “biggies” I mean pension, investment, and hedge funds, as well as large banks.

Having the investment portfolio is not only about the assets, but also the ability to manage capital and risks. Successful investing is impossible without a properly assembled investment portfolio.

Obviously, you don’t have to become a professional manager who knows and evaluates every little aspect, performs the fundamental and technical analysis, and checks accumulation options depending on the relevant timing.

Even though various options of investment portfolios produce lower returns, yet they still beat bank rates this way or another. If you are a newbie investor, you need to develop good capital distribution skills and have basic knowledge of mathematics.

Why there is no room for experiments in investing

Investing does not mean you need to keep your money under the mattress. The Inflation Monster will slowly but surely eat up your savings that way. So, another option here is to have a bank deposit.

I believe that most readers are not surprised by what happens to deposits in national currency. Everything goes well up to a certain point. Foreign currency deposits offer interests of about zero, while others get eaten up by the aforementioned inflation. Plus, the banks that seemed pretty stable once became history overnight.

So, once again, what does investing mean? It means having an understanding that only you as an investor can take care of your capital. But to do this the right way, you should not waste time on any time-consuming experiments. It is important to stick to sensible approaches, as well as those that have passed stress testing.

Аutor: Viktor Makeeu

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