Module 5 of 6
Understanding Risk & Reward
Learn about volatility, diversification, and the relationship between risk and potential returns.
The Risk-Reward Relationship
In investing, risk and reward go hand in hand. Generally, the higher the potential reward, the higher the risk. Safe, stable investments tend to grow slowly, while risky ones can swing wildly in both directions.
What Is Volatility?
Volatility measures how much a stock's price bounces around. A highly volatile stock might swing 5-10% in a single day, while a stable stock might only move 0.5-1%. Volatility is not inherently good or bad ā it is a measure of uncertainty.
The degree to which a stock's price fluctuates over time. Higher volatility means bigger price swings and more uncertainty.
Diversification: Do Not Put All Your Eggs in One Basket
Diversification means spreading your money across different stocks, sectors, and asset types. If one stock crashes, the others can help cushion the blow. It is one of the most important risk management strategies.
In your STONX games, try owning stocks from different sectors ā like tech, healthcare, and finance ā instead of putting everything into one company.
Spreading investments across different assets to reduce risk. The idea is that not all investments will move in the same direction at the same time.
Gains vs. Losses Are Not Symmetrical
If a stock drops 50%, you need a 100% gain just to get back to even. This is why managing downside risk is so important. A $100 stock that drops to $50 needs to double to return to $100.
Math works against you when losing: A 20% loss requires a 25% gain to recover. A 50% loss requires a 100% gain. Protecting against large losses is crucial.
Risk Management Tips
ā¢Do not invest everything in one stock ā¢Decide how much you are willing to lose before you buy ā¢Take profits along the way ā you do not have to sell everything at once ā¢Stay informed about the companies you invest in
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