One of the first things to decide before investing in the financial markets is the type of assets you want to focus your energy and time on. Trading the stock market can be a very profitable activity, but there are some guidelines that it pays to follow. We’ve gathered the top 5 tips you need to know before investing in stocks.

#1 Control your risk

Remember that you should invest only the money you can afford to lose. As with any investment, trading stocks is risky, especially if you’re using speculative financial products to take advantage of short-term price movements.

You need to determine your risk tolerance before you invest real money and adapt your strategy using appropriate position sizes and leverage, as well as stop-loss and take-profit orders.

#2 Understand volatility

When trading the markets, you need to understand that volatility can have a major impact on your performance. Volatility refers to the likelihood that an asset’s prices will change significantly and rapidly. Volatile assets can offer higher potential rewards – but they also present much higher levels of risk.

Like momentum – the strength of an asset’s price movement – volatility changes constantly and is an essential element of trading. Smart traders always research the full history of an asset and look to future events such as earnings reports to estimate future volatility.

#3 Diversify your stock portfolio

Diversification is all about reducing risk by allocating your funds in uncorrelated (unrelated) assets or industries. This technique will help you maximize your returns by investing in different categories of stocks that will react differently to the same events.

Diversification is one of the most important components of trading success, helping investors reach their long-term financial goals, while minimizing risk.

#4 Buy what you know

To make profitable investments in stocks, it’s a good idea to buy shares in companies from industries you have some knowledge of. If you know how companies in a certain sector make money – and the risks involved – you’ll be much better prepared.

It’s also best practice to research a company’s R&D strategy, its strengths and weaknesses, and the state of play in terms of its main competitors.

#5 Set realistic goals

Many new traders set unrealistic trading goals, hoping to achieve high returns on their investments very quickly. This is both unrealistic and counterproductive, as it encourages undisciplined and impulsive trading.

Having goals is good, as long as they are defined by a sensible structure like the S.M.A.R.T. system – Specific, Measurable, Attainable, Relevant and Timely.