Safe Trading

Written by Jacey Harmon
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Trading the markets carries an inherent degree of risk. Whatever type of investment you are trading, there will be risk involved. However, risk isn't exactly static or easily defined. Every individual investor has a different level of risk. What is considered high risk by one may be very low risk for another. Risk is different for investment classes and types. Highly liquid investments will carry lower risk than non-liquid investments.

Bonds will have varying levels of risk. A high yield bond--formerly known as a junk bond---will carry higher risk than a highly rated government bond. Over-the-counter stocks will have more risk than a stock traded on the New York Stock Exchange. The point is, every investment has some level of risk and it is unavoidable.

Investment Strategies that Reduce Risk

Everyone knows that diversification reduces risk with investing. Diversification also reduces the potential returns for investments as well. You can diversify amongst asset classes or investment vehicles. Fortunately, there are various other strategies that can reduce risk. Notice these strategies reduce risk, they do not eliminate risk.

One such theory involves using an option contract to "cover" your stock purchase. With this type of strategy you sell an option contract for every 100 shares of stock purchased. The idea behind this strategy is if the stock falls the losses are offset by the profit from selling the call option. If the stock price rises you simply sell the stock at the price specified in the contract and pocket the price from selling the contract.

Spreads can help reduce risk with trading futures and options. Spreads are when you buy one contract (long) and sell another similar contract (short). There are several types of spreads traders can use to mitigate risk with options and futures. These include calendar spreads, intermarket spreads, bull spreads, and bear spreads to name a few. It should be noted that common strategies used to reduce risk will limit reward in some fashion.


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