Risk Management Strategies in Stock Market
Even in the financial world, the first impressions matter. Stocks are considered risky assets due to which the new investors tend to stay away from them. But, did you know that the stock market can provide you huge profits once you learn to curb the market risks and start making smart decisions?
In this article, you’ll come across various strategies of risk management in the stock market.
What is Risk Management?
Risk management is a process that consists of identifying the risks you have and further taking specific measures to avoid those risks. Did you have an idea that mitigating risks is not as hard as it is said to be? Risk management focuses on mitigating and managing these risks in a smart way. Profit and loss are two sides of the coin named risk.
So, it is necessary to understand the importance of risk management in the Stock Market while trading. Here are some strategies you must keep in mind while trading your stocks.
Risk Management in Stock Market
The key risk management strategies to reduce losses and risk are as follows:
The Portfolio Diversification
To protect yourself from the market fluctuations in a specific sector, it is advisable to diversify your portfolio. Portfolio diversification means you can hold stocks from various unrelated sectors. This avoids exposure to one or a few of these stocks from various sectors. The stock prices of a business are at many times adversely affected by several uncertainties.
So, to prevent losses you must invest in multiple stocks. This ensures that even if some of the investments don’t perform well, the others would minimize their effect on the overall portfolio. Investing in stocks from the same sector would expose you to high market risks. Hence, to balance the losses of one sector, it is better to invest in different sectors to get good returns.
Following the Stock Market Trend
Trading against the market trends never yields profit. It is one of the most common mistakes that investors make. Make the buy or sell decision by using the candlestick pattern. It is a very important tool to know the stock market trends and hence for the risk management in the stock market.
Determining Stop-losses and Taking Profits
A stop-loss order is one that authorizes the broker to sell a stock when it falls below a specific level so that you’re safe from the losses caused due to sharp market corrections. So, you need to manage the risks by determining the open and close positions of a stock.
The stop-loss is the lowest point at which the investor targets so as to prevent further loss. It is helpful in minimizing the loss you would face when the stocks are nearing the support levels.
On the other hand, take profit is the highest point at a particular price level where the investor books profits or sells the stock before it rebounds.
The One Percent Rule
According to the one percent rule, in a single trade, you must not put more than 1% of your capital. To prevent substantial losses, even if you have a huge amount of capital, you must not put in more than 2% amount of your capital. It is one of the most common practices by investors for risk management.
Invest in Dividend-paying Stocks
Usually strong and established companies have a history of consistent dividend payments. Add these to your portfolio to shield you from equity risk. A dividend cut is seen as a sign of poor financial health. If you invest in dividend-paying stocks, it is ensured that you get constant returns even when the prices of stocks fall. Dividend-paying stocks bring more predictability and stability and hence reduce the risk of losses.
When you anticipate a huge price move and are not sure of its direction, pairs trading is an amazing way to reduce risks. Here, one buys the shares of a company and simultaneously sells the shares of a similar company to minimize the losses irrespective of the direction of the prices.
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So, whether the prices of a stock rise or fall, you always get profit from it. You only need to ensure that both the stocks aren’t related in any way and are more likely to benefit in different ways.
The Importance Of Risk Management in Stock Market
Risk management is very important in trading due to the following reasons:
- It protects from huge losses that you or your company might have to face in the future.
- You can plan your finances according to your risk-taking abilities.
- It helps you in taking the calculated amount of risks.
- You learn about the entry and exit points in stock trading.
- You learn to make good and profitable investment decisions for a better future.
We hope our article on Risk Management Strategies in Stock Market helped you. Learn more at Mahadevan Share Sense about various trading trends by going through our blogs.