When we talk about the financial market, the most common belief of any trader/ investor is that they will be able to the beat the risk in the market. Based on the research and experience, the traders choose their portfolio of stocks and very carefully starts monitoring the same, thinking that their strategy may eliminate any kind of risk involved. It is at that moment that they face the worst of the situation of not maintaining any cushion to the risk involved because the market is dynamic and is subject to huge fluctuations.
Risk management is a major disciplinary strategy to be taken before taking any investment decision. It involves identifying the probability of risk involved and applying the available resources for preventing any unfortunate situations in the future.
For example, when we purchase a stock, we always keep a profit margin and a stop loss figure to give a cushion to our investment/ capital involved. It is implied that the market is unpredictable; however, maintaining some risk management strategy saves us from a major to a minor bearable loss situation.
Now that we know what is risk management and why should we manage it, let us understand a few risk management strategies specifically related to the stock market:
Profit margin is the amount at which the investor is willing to sell the shares bought. Marking this margin is essential for an investor/ trader to minimize the risk when the probability of the future increase in prices are high.
An investor/ trader should always book profits before so that when the stocks are near their resistance level post huge gains, then the investor/ trader sells them before any consolidation/correction occurs and prices begin to fall.
Setting up stop loss:
Stop loss is the lowest price at which the investor/ trader agrees to sell off the shares to curb any further loss. This strategy helps the investor/ trader to curb the risk of an excessive loss in the situations where the market is not doing meeting his expectations.
Avoid emotions in planning trades:
Often investors get emotional with the market movement and buy stocks without planning their entry or exit levels and face huge losses.
An experienced trader always ensures to plan the same, along with preplanning of profits margins and stop loss. This helps them to book profits before any kind of unexpected market move.
Diversification of investment portfolio:
Another way to mitigate risk is to structure a diversified portfolio. This implies that an investor shall maintain a balanced portfolio of both equity and debt instruments. This will provide them a cushion of regulated returns.
Also, instead of focussing on one sector, an investor can create a bag of more than one sector. So when one of the sectors isn’t doing well, another sector may help the investor in meeting targets.
Monitoring market trends:
It is commonly said in the case of the stock market that “Trend is your friend, which is ideally itself a risk management strategy. An investor/ trader need to closely watch the market trend so as to ensure safety in any decision making. The market is volatile and keeps changing; identifying a short-term trend in a long-term timeframe will be itself a difficult job.