Its every investors nightmare. You buy the wrong stock at the wrong time, leap into a hot sector just as it turns cold, or lose your balance in a wider stock market crash. Result: Wipeout!
If you are investing in individual company stocks, you have to accept that it could happen to you.
Small-cap investors know they risk a soaking. And during the financial crisis, investors in the big banks also got drenched.
Here is how you can avoid getting wiped out.
Learn How To Value A Stock
If you are picking your own shares, you must do more than check newspaper headlines and past performance figures.
You are effectively gambling with your own money, so you need to know the odds. Is the share price underpinned by earnings? The price/earnings (P/E) ratio will tell you. Does todays price reflect how the company is growing? The price-to-earnings growth (PEG) ratio may show you the future. What is the real value of the companys assets. Find out fromthe price-to-book (P/B) ratio.
These wont tell you everything, but they will tell you a lot more than you knew before.
Spread Your Risk
Buy too many stocks and you dilute your chances of beating the market. But if your portfolio is too concentrated, one flop can wipe you out. Only you can decide how much risk you are willing to take. But even if you are assembling a portfolio of racy AIM-listed start-ups, you need to spread the risk around.
Dont Run Your Losses
People hate making mistakes, and they hate admitting to them even more. Thats why so many investors cling onto companies whose prospects have been sunk. They hope that by sticking around they will eventually claw back their losses. There are times when you have to grit your teeth and admit that you got it wrong. Then find a better home for whats left of your money.
Some people swear by stop-losses. They employ them as part of sophisticated trading strategies, to limit the downside of any trade. The danger is that they dont just stop your losses, but also lock them in. This strategy can backfire with volatile stocks, triggering a sale when the share price briefly dips, then locking you out of the subsequent rebound. Use with caution.
Keep It Simple
Work outwhy you are investing. Do your research. Only buy stocks you understand. Dont invest money you cant afford to lose. Track the share price before you commit yourself. Review your portfolio regularly. Dont get greedy: get-rich-quick investments are the fastest way to wind up poor. Finally, enjoy the ride.
If you can avoid a wipeout, the stock market can make you rich.
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How To Get Started With Small-Caps
Investing in a handful of cracking small-cap companies could bag you much bigger returns than a stodgy set of blue-chip stocks and may make a smart addition to your existing portfolio if you can handle a little more risk.
To help get you started, The Motley Fools Head of UK investing has prepared this special small-cap report featuring one fast-growing stock idea that he believes has breath-taking potential.