Risk Management
Stock market provides the same chance for investors to take their return, but so many investors could not earn enough returns and lose money, why ? Because they do not know what is risk management and do not use it.
There are different ways and definitions about risk management. Some people call it position sizing, while others call money management. Most of the books presented Risk Management so complicatedly that common investors unable to understands formulas for calculating the risk. But, in this user-friendly handbook, we describe it simple and practical as possible.
Maximize Returns
The potential return from any investment is generally depending to the amount of risk the investors is willing to assume.
Investors will not take on greater risks without the possibility of higher earnings. This is called the risk premium. In general, the greater the risk, the higher the potential return, the lower the risk, the lower the expected return.
Different markets have varies risks. Their volatility varies for example risk in the stock market, and currency market is not the same.
Also, each stock in the stock market has its own risk, because the volatility is varies. So, if a stock has volatility, you should invest less money in it.
Common Types of Risk
There are several main types of risk, and investors should understand them well because some affect certain investments more than others.
The two common risks that apply to almost all investments are :
Market Risk
The chance that financial markets in general may rise or fall in value.
Inflation Risk
May be the most important factor for long term investors to consider, because inflation is cumulative, and it compounds just as interest does.
You can’t control the inflation risk, but with a good strategy you can manage and control the affect of market risk on your stocks.
A professional trader always tries to understand and control portfolio risk. Before entering into any trade, good traders first think about how much risk to take and how much risk exposure comes with a
particular trade selection. Only then to they allow themselves to think about how much profit they stand to make.
Prudent investors always close their position and exposure if they determine that a portfolio carries too much risk.
Risk Management for a Trade
Before you decide to trade consider to these fundamental principles :
- Before you trade a stock, know how much you are willing to lose.
- Check the stock to be sufficiently liquid, could you buy or sell promptly ?
- Determine the cut-loss level before trading.
- Determine your profit target (take-profit-level).
- Buy the stock only at an acceptable price level. Use a limit order when you buy a stock.
- Immediately after the trade has been confirmed, enter the stop-loss level.
- Take profit when the trade reaches your profit target.
Portfolio Risk Management
Your portfolio risk will be well under control and you manage your portfolio risk actively, by
managing the risk of each trade. Follow the pointers to control your portfolio risk management.
- Determine your overall cut-loss level. Usually your portfolio should not lose more than 10 per cent of your capital.
- Diversify your investment in at least six or more different stocks.
- Know your overall risk tolerance before building up the portfolio.
- Act quickly when you see your risk limits exceeded.
- Close out the entire portfolio if it loses to your overall stop-loss level.
