In the world of stock markets, you cannot let go of the strong relationship between return and risks. With greater risks come greater returns. And there is a way to assess and identify the risk management procedure. This helps to develop strategies to minimise the risks and maximise the returns. In the Financial world, it is known as risk management.
Why is risk management important?
There is no shortcut to avoiding trading risks altogether. However, the right strategy for risk management goes a long way to cutting the losses down. It can shield your trading account from losing all the money even when the market health goes south.
It is not uncommon for traders to incur losses. And this is where market risks spring up. But when you are smart enough to manage it, you open yourself to churning out money, no matter the situation.
Mastering risk management is an important prerequisite indeed. But it often goes overlooked. And this is where many unforeseen problems spring up.
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How does the risk management procedure work?
Justifying the name, risk management becomes a game changer as it identifies the potential risks, assesses their likelihood in the market and maps the potential impact. Experts in finance implement the strategies accordingly to avoid or at least mitigate such risks.
Typically, the procedure of risk management involves certain steps:
- Identify: Have you reviewed your stock’s portfolio and identified the potential risks? If you think that’s tough, then industry experts’ opinions, market research and analysis of historical data can make it easy for you.
- Asses: When you know where the probable risks lie, you can also comprehend their chance of occurrence. You can also sense the probable impact on your investment portfolio and analyse the intensity of risk.
- Evaluate: When you know what your risks can be and how severe they can get, you can evaluate the portfolio on the basis of “priority”. This means that it can help determine which risks can be more “risky” and would need fast attention.
- Treat: After checking the capital market with risk management, it is time to set fitting strategies to manage the identified risks.
How diverse can risk management types be?
Some of the most common types of risk management in the stock market are:
- Management of market risks: Is the possibility of incurring loss due to a volatile market, inflation, fluctuations in the interest rate or sudden change in currency price. There are many solutions to managing such risks. Your financial advisor might consider tactics like hedging, active portfolio management and diversification, depending on unique situations.
- Management of credit risks: This is the possibility of suffering a loss due to the borrower’s inability to fulfil financial commitments, such as a loan. To avoid such risks, evaluating how creditworthy the borrowers can be is important. Also, check whether they have backs up, such as insurance or collateral, in case of default.
- Risk management for operations: This refers to the chance of loss due to any failure in the internal processes, people or system. The answer to such risks is the implementation of control procedures and measures to ease the various impacts of operational problems. It could be anything from disaster recovery to contingency planning.
- Risk management for liquidity: A company is likely to suffer from loss if it fails to change assets into cash. To manage such risks, it is important to maintain sufficient cash reserves.
- Risk management for shielding reputation: What strategy should the brands and companies follow if their name suddenly gains a bad rap? Managing such risks involves the implementation of specific measures. Experts often recommit strategies like monitoring the feeds of social media platforms and fast responses to negative feedback.
- Regulatory and legal risk management: The company you invested in might land on a wobbly phase if it breaks any regulation or law relevant to its business. Implementing processes and controls goes a long way to keeping such risks under check.
How to plan your trades in the stock market?
While training yourself about risk management in trading, you also need to plan well before any investment. Here’s a tip. Ensure that the broker you have picked actually trades frequently.
Some self-proclaimed professionals cater to several casual and infrequent investors. Choosing “cowboy” agencies might leave you paying hefty commissions. Even then, there is no guarantee of getting the best analytical tools for near-perfect speculation.
When to set your Stop-Loss and Take-Profit Points in the Stock Market?
Stop-loss (S/L) and take-profit (T/P) points are the two ways to help you plan before you start trading. Someone succeeding in trading risk management always stays confident about the price they are ready to purchase.
They are also straightforward about the price they would set to sell the stock. On the flip side, unsuccessful and novice traders often tend to depend on a gambling style unlucky -or lucky streak to set prices for their trades.
Want to clear the fog of risk management further?
Basically, the stop loss point is the amount that one trader intends to sell a stock, even if it means facing a loss on the trade. This comes into play when any trade does not flow in the way its trader expected it to.
Again, the point of take profit refers to the amount that a trader sets to sell a stock and enjoy the profit. This is a fine strategy to follow when your trade enjoys a huge upward push but starts approaching a level of resistance thereafter.
Who should consider the One-Percent rule in the stock market?
This is a tiny but powerful rule of thumb from the biggest investors in the country. The trick is not to put more than over 1% of your trading account or your capital in one trade.
So the thing is, when you have about INR 10,,000 in the trading account, then your investment in any trade should not be more than INR 100. However, if you can afford it and feel that it is worth taking a risk, then you can invest as much as 2%.
If you invest more than that, then you need to equip yourself with substantial Risk Management in Stock Market. In the US, the rule of 1% is a common strategy for investors having accounts lower than $100,000.
Should you opt for blue-chips in the stock market?
Not all stocks rank the same on the risk radar. The stocks that medium and small companies sell are more vulnerable to business risks than their bigger counterparts. That is why stocks from such companies can be volatile. Established businesses, however, can stay stable in the market. So as a new investor, you might want to play it safe by purchasing stocks of well-known establishments.
What about pairs trading in the stock market?
Your financial expert might suggest this strategy to manage equity risks. They can be helpful when you expect a positive price move, yet you are not confident of its direction. Pair trading enables you to buy the stock of one company and short-sell the same of another company. Short selling, as you might have known, refers to selling the stock of one company and buying it later. However, ensure that the companies you choose belong to the same sector.
The Bottom Line
Buying stocks can be, by all means, a risky investment. The movement of price can be both unexpected and volatile. But implementation of the right risk management tools can give you cover for all the potential losses.
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