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.As an investor, there would be no greater thrill than to wake upccc_payne_259-284_ch11.qxd 3/13/07 8:02 AM Page 261Risk and Reward 261one morning and learn that XYZ Biopharmaceuticals has just beengranted FDA approval for a cure for lung cancer.That would belike the most famous home runs in the history of baseball, the shotheard around the world (Bobby Thompson), the Kirk Gibsonhome run in the World Series when he could barely walk to theplate, and the three-home-run performance by Reggie Jackson, allrolled into one.It s good to dream, but in the stock market it is so much moreimportant to adjust for and plan for risk and worst-case scenarios.What is the difference between a professional investor and theaverage individual investor? The professional investor assessesthe risk; in many cases it s the first thing he looks at what is theworst that could happen? By contrast, individual investors are al-ways counting their chickens first, daydreaming about how hightheir holdings will go without regard for the possible downside.In order to become rich in the stock market, you have to con-sider and master the following:Understanding and planning for riskDistribution and allocation of assetsTiming and exit strategyResearching and understanding your portfolioIn order to control your risk and reward properly, you have tobe able to control your emotions throughout the entire investingcycle.Riding Out the Bumps in the RoadHandling the ups and downs of the market is the key to success.Mostly handling the downs is the key to success in the market,and the difference between becoming a frustrated day trader orsomeone who stays cool and creates wealth.If you enter the stockmarket thinking every stock is going to go straight up, you re introuble.If you enter the stock market and sell stocks on every dip,you ll be real broke, real fast.I ve met a ton of traders who usestop-losses yet have the same amount in the money today thatthey had three years ago.ccc_payne_259-284_ch11.qxd 3/13/07 8:02 AM Page 262262 ACT AND GET RICHYou must understand there are life cycles to the market and toeach investment you re going to make.Life CycleThe life cycle of an investment begins the moment one takes theposition (going long or short) and lasts until the moment one exitsthat position (selling a long idea or buying to cover a short).Eachphase of the life cycle carries a certain amount of risk and chal-lenges that must be constantly assessed or reassessed.The mainimpediment to becoming rich in the stock market is the fact thattoo many investors are closing positions during the period theyshould be holding and, to a lesser degree, holding when theyshould be selling.It is folly to expect any stock to be able to go upin a straight line.Armed with the tools in this book, you will havethe confidence to hold companies that are simply under pressurefrom the crowd.BUYING This is the easiest part of the life cycle of an investment.Let s face it, anyone can come up with a hot investment idea, andeveryone will, at one time or another.At this stage of the game in-vestors should already know the following:How much they are looking to make.The upside should be real-istic, although at the end of the day a great company is going toreturn so much more than you ve become accustomed to.Thekey is to hold it.How much they are willing to lose.When you take 2 percentprofits out of fear of the stock being down the next day, then youare going to have to play it close to the vest on the downside,too, or a 10 percent loser will wipe out five would-be winners.Why this idea? Is it a tip, hunch, wild guess, or was real funda-mental work used to come up with the idea? With real funda-mental work you are prepared to be an owner of the company.HOLDING Riding the waves is tough.Since 2000 those waves havebeen so wild and erratic that even staid, dyed-in-the-wool, buy-and-hold types have taken hits and bailed out.Mastering this partccc_payne_259-284_ch11.qxd 3/13/07 8:02 AM Page 263Risk and Reward 263of the life cycle of an investment is where you will get your blackbelt and open the door to riches.Of course, there is a big differencebetween holding on to hope and holding on to value.EXITING This is really the hard part, isn t it? We worry about get-ting out too soon, leaving money on the table, looking at thoseriches that were within our grasp.Many of the same factors thatdetermined why you took the position will and should determinehow you exit.Of course, I want to make sure you enter invest-ments for the right reasons so that you exit at the right time, too.Types of RiskRisk is what we take the moment our eyes open in the morning.There is a chance the water in the shower could be too cold or toohot; the former makes for a jarring wake-up call, the latter makesfor a possible visit to the hospital.But of course we have knobsthat clearly indicate hot and cold, and we also have to ability tofeel the water, testing for the moment it reaches perfection.As the day moves forward the risk increases exponentially.We,however, moderate our lives to adjust for risk.If that nut in thecar in front of you looks like he has had too much to drink, yousimply switch lanes and move around him, maybe giving him adirty look as you pass by.You continuously check and assess riskwhen you drive your car, looking at the rearview mirror everyfew seconds.You are always checking, monitoring, and preparing for un-pleasant events in your life.You probably dread doctor visits (Iknow I m not alone in this), and yet the earlier an ailment is dis-covered, the greater the chance of curing or fixing those would-beproblems.We buy life insurance although we avoid dwelling onthe inevitable.For the most part we are always checking and as-sessing risk in our lives: Can I really jump over this puddle of wa-ter or should I just take the longer route and stay dry?And yet you and the overwhelming majority of individual in-vestors don t feel for the comfort level of your portfolio the wayyou do in the morning shower to make sure it s just right [ Pobierz całość w formacie PDF ]