Friday, March 21, 2008

Avoid Risk of Single Stock Failures

Several means remain available today to avoid or minimize risk involved with business failures for the equity holders. According to business survival statistics I had listed in the past (Stock Market Downside Bets), it moves below 50% after five years of operations. Managing this form of risk is crucial for the long term bullish investors.

Exchange Traded Funds

Making mutual funds obsolete, these listed baskets of goodies have become available to the general public with a variety of underlying stocks or commodities without the hefty management fees. The commodity ETF’s such as silver, gold, or oil pose virtually no risk of bankruptcy outside of the expected volatilities.

Insider Transaction Analysis

If the insiders have expressed way more volume in selling than buying in the past few months, it means they believe the price will likely dip. Since they always know more about the business operations than the public, their sentiment usually carries some weight.

Investment of Short Positions Exclusively

This would allow the investor to reap exceptionally large rewards off corporate disasters. It usually couples with heavy volatility, e.g. Bear Stearns stocks had gone from $54 to $3 over a single weekend this month (Mar. 08). A statistician speaker at the Auckland University of Technology had mentioned that one in four corporations experiences a calamity that it will never recover from, every 5 years.

This type of investment naturally completely mitigates the risk of loss from business failures, and carries a positive statistical expectancy. But it carries unique forms of risks and takes a much more active management to pull off.

Basic Options

If bullish, a basic position in a call option or leap would allow for unlimited profit potential, yet limited loss due to lowered cost of the option contracts. Of course, the game with options compared to underlying stock/commodity trading resembles that of chess with checkers. A whole variety of strategies exist to profit off underlying price or volatility swings. The serious investor would find value learning about options.

Final Words

As shown, it all simply takes a bit of research and discipline, and average investors can preserve capital, mitigate financial misfortunes. Like everything else good in life, a little bit of diligence could go a long way.

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