How to Make Profits in the Stock Market and Limit Your Risk

The stock market is a place for businesses and investors to exchange ownership in companies (in the form of shares) for capital. Like every other potentially profitable business transaction, stock market trading involves risks. Investors have to make these risk-reward trade-off decisions when trading. The stock market has several investment options from low-risk stocks with steady if unspectacular returns, to high-risk stocks that offer both spectacular profits and losses. To maximize profitability and limit risk, think long term, plan, research and ignore day-to-day market volatility.

Conduct research in companies that you know and understand. Examples include grocery stores, hardware stores and car manufacturers. If you work in the financial services sector, then the stocks of banks, insurance companies and brokerages might be of interest. Review their financial statements. Analyze how changes in the economy and the competitive dynamics could affect their profitability.

Prepare a list of stocks to follow. Sign up for press releases from the investor relations sections of corporate websites. Set price levels at which you would consider buying these stocks based on your research and the historic price range of each stock.

Determine an investment strategy suitable for your risk tolerance. For example, if you do not have the time to follow the markets every day and are not worried about market volatility, consider a buy-and-hold strategy. Used by famed investor Warren Buffett and others, this strategy involves buying quality stocks and holding them until the business fundamentals worsen. A variation of this strategy is systematic investing, in which you invest a set amount periodically, thus averaging out high and low price points over the long term. Momentum investing involves following market trends. It is a more high-risk strategy because it is very difficult to consistently time the market perfectly.

Ignore short-term market volatility. Markets react to all sorts of news everyday. Treat these sharp price moves as noise. For example, markets around the world could fall because of a natural disaster or political turmoil somewhere. This could lead to paper losses for your portfolio. However, if the underlying reason for the market drop has nothing to do with the business fundamentals of the stocks in your investment portfolio, ignore these gyrations.

Diversify your portfolio to spread the risk across multiple stocks and industries. A simple diversification strategy is to invest in stock mutual funds and exchange-traded funds. These are professionally managed pools of money with different investment criteria. Stock mutual funds invest in stocks in different industries to maximize profits. Exchange-traded funds trade on major exchanges and track broad market averages.

Monitor your portfolio periodically. Reduce or replace unprofitable stocks and buy quality stocks that have become inexpensive because of market downturns.