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Can You Handle Volatility?

How Do You React To Ups & Downs?

All stock investments are volatile, even when you're simply following an index. Unlike an index fund, we're not selecting a pool of several hundred stocks. Our strategies usually require you to hold the top five stocks selected by one of our screens. Also, many of those screens select stocks that are more volatile than average. Even if you build a diversified portfolio of stock strategies, there are bound to be some big swings up and down.

Before you jump into any investment strategy, you need a good idea of how much downside risk you can handle. (Interestingly, most people don't have a problem with upside volatility). How would you react if your stock portfolio dropped 20%? 30%? 50%? The question isn't "how would your portfolio balance be affected?"

The question is "how would you react emotionally?" Be as honest with yourself as possible. If a 30% drop would cause you to panic, then think twice about how much you want to invest in a mechanical screen. Also, be sure to check the historical volatility of our screens before you invest. If you are going to sell when your stocks drop, then you won't stay in the strategies long enough to reap the rewards.

By The Motley Fool