In the Mirror: How to Avoid Major Losses Past the Second Quarter

Article first published as In the Mirror: How to Avoid Major Losses Past the Second Quarter on Technorati.

Wall Street's second quarter saw quite a wild ride in becoming the worst quarter since the first quarter of 2009. It witnessed the credit crisis in Greece, the BP oil spill, a change in government in the UK bringing about austerity measures, and, perhaps most notably, a true correction, with all the major indexes declining more than 10% over the period.

While the president and other members of government have forecast a quick end to the country's economic struggles, the Federal Reserve Board has advised caution, keeping interest rates low amidst fairly constant jobless claims and concerning consumer confidence levels. How can the rational investor make a profit in this climate which is at best stagnant, and at worst highly volatile?

The traditional way is to steadily invest in well-known funds that mirror the performance of the market, or some sector of it. In this manner, one can bet on the success of financials or pharmaceuticals, large companies or small companies, companies that yield high dividends or ones with high potential for growth. However, most of these funds are proud if they did not lose money over the past 5 or 10 year period.

The only way to consistently make money is to take risk. Unfortunately, that is also the best way to lose money. One can limit exposure to risk by doing these four things:

1. Diversify. Markowitz showed in the 1950s that any diversification lessens the overall risk of a portfolio.

2. Research. If even picking two random stocks provides less risk than one random stock, imagine the benefits of choosing two securities from different sectors that you know something about.

3. Monitor. An easy way to shorten your lifespan is to constantly monitor the value of your portfolio. I know a story of the trader who requested a portfolio monitor in his hospital room while undergoing triple bypass surgery. However, a daily scan of the news and earning reports pertaining to your stocks and watchlist can help ensure that you buy and sell at the right time.

4. Avoid IPOs. The Tesla IPO has made headlines for several days and many amateur investors are chomping at the bit trying to get ahold of these first shares. Unfortunately, all the big players on Wall Street have access to the IPO first; therefore you will only be able to jump on the bandwagon as it has reached apogee and is falling back to earth.

By following these principles, the rational investor can find underrated securities with healthy risk while steadying himself against the tide of the economy.