These are difficult times for stock market gurus. Predictions have become hazardous. Exotic factors which we do not understand trigger unexpected trends. Natural disasters and instances of executive malfeasance lurk in the background of most stock trading.
Scenario planning does not cost much in dollar terms, but it does take many hours and effort. However, pay-offs are commensurate by all business standards. The chances of escaping adverse events with only minor damages brighten this scenario. Besides, it gives stock investors opportunities to test the resilience of personal financial planning, much as major corporations do with their business plans.
Here is a five-step scenario planning method that investment clubs and even individuals can use for risk management:
1. Brainstorming: list all the risks you can imagine. Ask others to contribute. Some adverse events are secular, while others are specific risks of sectors, industries, and individual organizations.
2. Probability and seriousness categorization: you will not have time to consider all risks in detail. You cannot do much in an earthquake. There is no gain in worrying about every minor disruption either. Make a short list of serious, probable, and controllable adverse events.
3. Preventive and contingency action planning: establish information systems to warn you about unusual stock movements. Hedge as much as you can afford. Keep cash ready to meet threats. You may not be able to prevent many stock market downsides, but you can provide for them.
4. Rehearsing: does your broker disappear when you need him or her most? What if you have to travel on a key trading day? Do you get confused when the stock market moves rapidly? Perhaps a written plan will help.
5. Reviewing: you never stop learning from stock market set-backs. Every serious incident deserves a scenario planning update. You could be affected next time even if today’s bad news does not concern you. It is also a matter of staying poised to take best advantage of every sudden windfall.
Scenario planning distinguishes the best stock investors from others. Nothing succeeds like success, but there are major gains to be had by learning to deal with acute adversity.
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