Downside Protection and What It Means for You

by Andrew McGuinness     Jul 16, 2019

So, you’re new to the world of investing and are keen to keep your portfolio safe. You have some risky assets, some more prudent ones, and your portfolio is relatively diversified. That’s all there is to it, right? Wrong. There are actually several other ways of keeping your portfolio away from harm.

One significant focal point that traders consider when trying to keep their portfolio safe is their losses. Losses can be suffered by any investor. Whether you hold a portfolio filled with assets, or have only made one investment with your funds, you are at risk to suffer losses. For this reason, the trader world has a little thing called downside protection. Here are 3 important facts about what downside protection is, how it works, and how you can benefit from it.

1. What is downside protection?

Downside protection consists of methods that countless experienced investors use in order to make the losses they do suffer less damaging to their portfolio and capital. In order to avoid these dramatic losses, you can buy an option in order to pursue your hedging possibilities, purchase underlying assets that may help balance and protect existing investments in underlying assets, or you can employ stop limit orders.

Again, strategies employed in order for losses to be sustainable are called downside protection. What downside protection does is gives a limit to the range of how much money you will be losing per transaction you have chosen to confirm. In other words, the range of money you might lose through trading or investing is limited to the amount you discover is its premium, both avoiding losses that are too substantial and remaining in the market for any potential profit that is to come.

2. How do you deal with losses?

With downside protection, dealing with losses is obviously not magically possible for every investor. The trick to dealing with losses is quite simple, however. It is not possible for everyone to successfully deal with substantial losses. The trick is actually no trick whatsoever.

If you are faced with considerable losses, the only thing that will save you is if your portfolio is filled with returns that are even the slightest bit higher. The point is to balance your portfolio well enough that not only do your profitable assets recover what your losses take away from you, but that they thrive beyond that point and gain you enough profit to stay on the market.

3. Different strategies for different investors

There is no single strategy with downside protection that will suit every type of trader. Downside protection is adaptable according to what you can handle, the losses you are able to manage, the profits you would like to aim for, and how difficult it would be to get back on your feet if these investments do not go according to plan.

The most important part of a majority of investor’s portfolios is, however, how well it is able to defend itself in the market. If a portfolio is strong enough, there is no need to worry about how extensive losses might become. The main goal is to have your feet in some of the best stocks on the market in order to properly defend against all losses you could possibly suffer and come out from every market dip or crash thriving. No matter what risk you take, your best stocks should be able to take the blow.

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