A Few Things to Consider When Investing
Investors and traders have the same objective – increasing the size of their portfolio. However, a big difference exists between the time horizon to achieve that.
Typically, traders are more “anxious” and active in managing a portfolio. On the other hand, investors “marry” with their positions for years and years and settle for much less than traders do.
Leverage is one thing that investors often use. Buying on margin appeals to many investors, and the process goes like this. If, for instance, the account has a buying power of $50k, the investor borrows from the broker and increases its buying power two or three times. The leverage gained this way allows investors to participate more on the upside of a stock. However, the risk increases exponentially too. If the price of the stock reverses, the broker will issue a margin call should the investor not come with additional funds to sustain the bigger position.
In other words, leverage is great but try to avoid it as much as possible. It makes sense only when used on a very long-term horizon and with a limited exposure versus the size of the investing account.
Protect the Downside
One trait investors have, and traders struggle at is the downside protection. More precisely, risk management. Investors often have speculative balances available to participate in a market decline. In other words, investors wait for the right opportunity sometimes for years, and when it comes, they do not hesitate to execute it. It sounds easy, but it is not. Doing nothing for a long period of time when involved in financial markets is exceedingly difficult. Sitting on your hands and doing nothing is just another position or stance in the market.
Downside protection comes at costs. Investors often protect the account ahead of potential risk events. The easiest way to do so is to buy puts as protection. These puts are options that give you the right but not the obligation to trade at expiration. Most of the time the puts expire worthless, but their cost represents a cost associated with the downside protection of the trading account.
To sum up, avoiding leverage and having a cash balance to profit from a decline in prices is the best way to protect the downside. And the things that make investors different than traders.