Is it any riskier???

One of the comments I often hear about the market after it has been trending up for a while is that it is now "too risky" to hold stocks. The thinking is that once stocks have gone up a lot, the risk of buying is increased.

Whether that is true depends on how you define "risk."

In theory, if you buy the Nasdaq when it's at 2300 rather than 1900 you have greater risk because there is more potential downside, but what that thinking fails to take into account is the ability to limit our losses by selling.

If we have the ability to sell a stock when it has pulled back a certain amount is our risk any greater if we buy at $20 instead of $10? Do higher prices necessarily increase risk if we have the ability to apply money-management discipline?

This same logic is often used in an attempt to convince investors that shorting is much more risky than going long. The argument is that when you short a stock your losses are theoretically unlimited! The stock could increase 1,000-fold and you would be wiped out! The problem with that argument is that it assumes you are somehow incapable of covering your position before your loses reach a billion dollars.

Risk has little to do with absolute price levels. The real risk most investors have to contend with is news after the close that causes big gaps. When that occurs you don't have the ability to use your money-management rules to cut losses. The higher the market goes, the greater the risk of a dramatic reversal overnight that leaves you unable to keep losses small; but most investors greatly overestimate the potential far a big overnight crash. It might occur if there was a major terrorist attack in the U.S., but if you worry about that possibility you'd be sitting on the sidelines for the last four-and-a-half years. More money is lost anticipating a crash than has ever been lost in an actual one.

So is this market really much more risky than it was six months ago? Theoretically, there is more downside since prices are higher, but if you use good money management then the risk is not significantly greater at all.