Playing the stock market is a common but misleading phrase: The stock market is not a game and it does come with investment risks.
To some degree, those risks can be mitigated by using certain strategies, including using a more long-term, buy-and-hold strategy and embracing diversification, among other things.
And while investing is a serious business, playing the stock market can have an element of fun to it in the sense that investors who do their research — and tune into the news and business cycles — can take advantage of trends that might enable them to earn better returns on investment.
Playing the Stock Market: What Does It Mean?
Despite the phrase “playing” the stock market, it’s important to make the distinction between investing and gambling up front.
While both gambling and investing involve risk, investing actively attempts to manage various forms of risk, rather than relying on blind luck. Second, smart investing involves a strategy, something that a gambler pulling the lever on a slot machine can’t employ.
But because all investing involves an element of risk — there is no 100% safe investment — in a way each investment can feel like a gamble. However, it’s important to keep in mind that the market is not a casino, and just because there’s risk involved doesn’t mean that “playing the market” is the same as playing roulette.
Playing the Market: Risks and Rewards
Learning how to play the stock market — in other words, become a good investor — takes time and patience. It’s good to know the basics of the risks and rewards.
Potential Risks
In a broad sense, the most obvious risk of playing the market is that an investor will lose their investment. But on a more granular level, investors face a number of different types of risks, especially when it comes to stocks. These include market risk, liquidity risk, and business risks, which can manifest in a variety of ways in the real world.
A disappointing earnings report can tank a stock’s value, for instance. Or a national emergency, like a viral pandemic, can affect the market at large, causing an investor’s portfolio to deflate. Investors are also at the mercy of inflation — and stagflation, too.
For some investors, there’s also the risk of playing a bit too safe — that is, they’re not taking enough risk with their investing decisions, and as such, miss out on potential gains.
Potential Rewards
Risks reap rewards, as the old trope goes. And generally speaking, the more risk one assumes, the bigger the potential for rewards — though there is no guarantee because risk always entails the possibility of losses as well. Investors may earn returns in a couple of different ways:
• By seeing the value of their investment increase. The value of individual stocks rise and fall depending on a multitude of factors, but the market overall tends to rise over time, and has fully recovered from every single downturn it’s ever experienced.
• By earning dividend income. Dividends from stocks can also be reinvested, in order to further grow your investments.
• By leaving their money in the market. It’s worth mentioning that the longer an investor keeps their money in the market, the bigger the potential rewards of investing are.
How to Play the Stock Market Wisely
Nobody wants to start investing only to lose money or see their portfolio’s value fall right off the bat. Here are a few tips regarding how to play the stock market, that can help reduce risk:
Invest for the Long-term
The market tends to go up with time, and has recovered from every previous dip and drop. For investors, that means keeping their money in the market for the long haul can be one strategy to mitigate the risks of short-term market drops.
As another common saying has it: “Time in the market beats timing the market.”
Consider: If an investor buys stocks today, and the market falls tomorrow, they risk losing a portion of their investment by selling it at the decreased price. But if the investor commits to a buy-and-hold strategy — they don’t sell the investment in the short-term, and instead wait for its value to recover — they effectively mitigate the risks of short-term market dips.
That said, you can’t rule out the risk of a downturn from which the markets never recover. It’s never happened, but no one has a crystal ball.
Do Your Research
It’s always smart for an investor to do their homework and evaluate a stock before they buy. While a gambler can’t use any data or analysis to predict what a slot machine is going to do on the next pull of the lever, investors can look at a company’s performance and reports to try and get a sense of how strong (or weak) a potential investment could be.
Understanding stock performance can be an intensive process. Some investors can find themselves elbow-deep in technical analysis, poring over charts and graphs to predict a stock’s next moves. But many investors are looking to merely do their due diligence by trying to make sure that a company is profitable, has a plan to remain profitable, and that its shares could increase in value over time.
Diversify
Another risk-mitigation strategy that investors can employ is diversification. Diversification basically means that an investor isn’t putting all of their eggs into one basket.
For example, they might not want their portfolio to comprise only two airline stocks, because if something were to happen that stalls air travel around the world, their portfolio would likely be heavily affected. But if they instead invested in five different stocks across a number of different industries, their portfolio might still take a hit if air travel plummets, but not nearly as severely as if its holdings were concentrated in the travel sector.
Use Dollar-cost Averaging
Dollar-cost averaging can also be a useful strategy. Essentially, it means making a series of small investments over time, rather than one lump-sum investment. Since an investor is now buying at a number of different price points (some may be high, some low), the average purchase price smooths out potential risks from price swings.
Conversely, an investor that buys at a single price-point will have their performance tied to that single price.
The Takeaway
While playing the market may be thrilling — and potentially lucrative — it is risky. But investors who have done their homework and who are entering the market with a sound strategy may be able mitigate those risks to a degree.
By researching stocks ahead of time, and employing risk-reducing strategies like dollar-cost averaging and diversification when building a portfolio, an investor is more likely to be effective at mitigating risk.
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