How to construct a high-risk portfolio
Beginner Stock Market Investing, Stock Market Investing Advice, Stock Market Investing Strategies
Most of the investment advice that you would read concentrates on achieving the best possible return with the least possible risk and the emphasis is on avoiding high-risk investments. Most of the time, this is the kind of advice that investors are looking for but, at least some of the time, there are investors who would like to look at the other side of the coin and actively seek high-risk investment with the objective of generating the maximum possible return. Many of these investors would be willing to allocate part of the investment to a high-risk portfolio and seek the trade-off of a higher reward in return for the willingness to lose some of their capital.
The relationship between risk and reward is neither consistent nor predictable but what can be said with certainty is that if you are seeking higher rewards, the only way for you to do so is by taking a high degree of risk. Realistically, there is no such thing as a low-risk high reward investment unless you are looking at investment fraud for which this is a typical claim. In general, however, it needs to be said that investors should not necessarily be completely risk averse and risk management is not about avoiding risk but choosing the right risk. You may think, for instance, that an all-cash investment portfolio is completely risk free but you are forgetting that a high rate of inflation will erode your portfolio by reducing your purchasing power.
Large investors require a degree of liquidity in their investments because they need to be able to buy and sell substantial amounts of stock. This consideration does not apply to retail investors for whom even a relatively low daily trading volume can provide adequate liquidity in relationship to the size of their investment. This is why large investors cannot readily invest in penny stocks or small cap stocks that trade on exchanges like the OTCBB. Retail investors have no such restrictions and can take advantage of the high risk/high reward opportunities that these investments offer. The other thing that you should bear in mind is that volatility and risk are not synonymous. Volatility refers to the price fluctuations in the stock price whereas risk refers to the probability of losing money on the stock. A stock price may gyrate wildly (volatility) but produce an acceptable return at the end of the day (risk).
High-risk portfolios may be of the following types:
- In a concentrated portfolio, all you have to do is to significantly increase the share of a particular industry or a particular sector such as commodities like crude oil. This will increase the risk of your portfolio and should provide superior returns if your judgement was correct. You should only follow this technique only if you have considerable technical expertise in a particular industry or sector and have the confidence to read the signs correctly.
- In a momentum investing portfolio, you increase your investment in stocks that are showing strong upward price momentum already. The problem with this strategy is that stocks that show strong price momentum can be really expensive to buy.
- A penny stock portfolio defies many of the recommendations of conventional experts but can nevertheless make money despite the exceptional risk. You will require to do a lot of homework while maintaining discipline in your trading judgement and creating enough diversification within the portfolio.
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