Risk is a threat when it comes to investing and trading financial assets. It blocks the trading opportunity and hinders profit size. So, the management of these risks involved with a specific trade or stock is vital. The article deals with common risk management strategies for stock market traders.
What is risk management in the stock market?
Risk management refers to assessing, identifying, prioritising uncertainties or risk, monitoring, controlling, and mitigating risk and its impact by applying or following various strategies. The multiple approaches to overcome risk entitled with particular trade or stocks are listed further in the article.
Top 10 risk management strategies
1) Mitigating risk
Mitigation declines the likeability of risk occurrence or decreases the influence of the risk within tolerable limits. This risk management strategy lies in the fundamental principle. This principle states that the actions taken to mitigate risk, impact or risk of probability of risk are generally more effective than fixing the damages after their risk occurrence.
2) Avoiding risk
Avoidance eradicates the associated risk by eliminating the root cause. It might lead to pursuing a trade differently. Traders may also isolate or change their objective, which is in trouble. Several trade risks can be avoided by an early gathering of data by advancing communication between the shareholders or employing various indicators.
3) Employing stop-losses
A stop-loss order is an essential tool which gives your financial service provider the right to automatically sell your stocks when it declines below a certain point. Stop-losses secures you from the sudden and unpredictable market shift hence protecting you from excessive losses. It could be understood by an example if you purchase a stock for Rs 200 with a stop-loss of Rs 190, your financial service provider will sell the stock when it declines to Rs 190. It secures you from further losses in case stock declines below Rs 190.
One such legitimate firm offering stop-loss orders is Global TradeATF. It is a well-regulated firm working under the guidelines of the Cyprus Securities and Exchange Commission. Thus, we can say Global TradeATF is not a scam broker. It is a safe venture to invest with. The minimum deposit to open an online trading account with the brokerage firm is $250 without any trade commission. It earns from swaps and spreads.
4) Diversification of trading portfolio
Businesses are sensitive to several uncertainties which unfavourable influence the price of stocks. To secure your trading portfolio from huge losses try to invent in multiple baskets or stocks. It guarantees that even if your stocks do not perform as per anticipation, the other stocks reduce their effect on the total trading portfolio. While diversifying your portfolio, make sure that you attempt to invest in those shares which do not have anything in common. Investing in the same stocks will automatically expose you to similar defeats and risks.
Also, note that diversifying your portfolio does not indicate investing an equal amount in all sectors. It reflects that investing in more than one sector or stock. You can spend more on firms in which you are more optimistic. Do not indulge so much into the trade that you can’t take losses if things go against your prediction.
5) Adding non-cycle to the trading portfolio
Non-cycle firms sell necessary items, including FMCG (fast-moving consumer goods) and pharmaceutical stocks. It is because of this industry in everlasting. People cannot stop spending their money on groceries, healthcare, irrespective of the economy, county and state they live in. At best, they might mitigate their spending on several necessary services and goods. Non-cyclical stocks are a comparatively stable instrument for revenue generation that transform into steady stock prices. Many experts and analysts call these as a defensive stock.
6) Spend in dividend-paying stocks
It includes firms which have a long history of providing consistent dividends. Usually established and stock firms fall under this category. Adding these firms in your trading portfolio can protect you from the sudden price shift risk in the equity market.
These firms are usually unwilling to lower their dividends as the market takes this dividend decline to indicate a firm’s poor financial health. These dividend-paying companies also make sure that you get a steady return even if their prices decline. Thus, they mitigate risk by bringing more stability and predictability to your trading portfolio.
Hedging is a risk management strategy which uses derivative tools such as options contracts or futures contracts for risk management in the stock market. A future agreement is a contract signed between two parties to sell or buy a particular asset at a predetermined date on a fixed future date. Using this contract, you can mitigate the risk due to price fluctuation. For instance, if the share declines, you can sell it at a higher value (which you fixed). In the same way, you can purchase at a lower price if the price surges. There are various types of derivative agreement which you can use.
8) Investing in blue-chips stocks
When we are broadly discussing risk in the stock market, it does not mean that all stocks are risky. Stocks of medium and smaller size firms can be more volatile and more dangerous in the stock market. It is because such firms are more inclined to several business risks. Established firms at the same time can be more steady. It is applied to their stock prices also. Thus, you can mitigate risk by going with such stocks.
9) Making a plan
Building a strong plan beforehand, which contains entry points, exit points and risk management strategies helps a lot while trading in the stock market. It is a blueprint that prevents you from making any emotional decision and guides you on different prices.
Acceptance is the only strategy suitable, especially when no other approach is available to eradicate the risk. Acceptance can be of two types: active approval and passive endorsement.
The Bottom Line
Risk management is a crucial aspect of the financial market. It plays a vital function when you are trading in the stock market. Thus, building a strong management strategy can help you to harvest most out of the market. Some of the techniques are mentioned in the article.
Apart from these, several financial service providers offer various tools to anticipate market price shifts and mitigate risk. You can opt for the globally famous Global TradeATF. It provides various educational and research tools such as trading signals, latest news, report season calendars, and the economic session calendar.
Frequently asked questions
What is risk management?
Risk management refers to assessing, identifying, prioritising uncertainties or risk, monitoring, controlling, and mitigating risk and its impact by applying or following various strategies.
What are some popular stock risk management strategies?
You can use many risk management strategies. The primary ones are:
- Diversifying your trading portfolio
- Using stop-losses
- Adding non-cycle to the trading portfolio
- Spending in dividend-paying stocks
- Investing in blue-chips stocks
- Avoiding risk
- Making a plan
- Accepting risk