Risk management strategies in trading and investing

Investment in stock markets always involves some kind of risk of losing money due to the volatility. While an investor can generate huge profits by investing in right stocks, the gains may also be lost in one or two bad trades due to some risks that companies face in a business environment. Investing in stocks for beginners needs a more cautious approach than the seasoned traders. A well planned strategy, knowledge about stock markets and some trading can help the beginners to minimise risk.

Companies operate in a dynamic environment exposed to several risks such as political, economic, geopolitical, climate disaster or global pandemic and others. Their underlying stocks also carry the same kind of risk. On the other hand, volatility in the broader market could be triggered by multiple factors from domestic macroeconomic conditions to global disturbances.

It is important to know about risk management strategies in stock trading to minimise losses. Here are a few investing mantras that can help save an investor from losing his or her money.

Let’s take a look at top five risk management strategies, which can help investors cut down losses and protect them from losing their hard earned money.

Portfolio diversification

Putting your investment in various assets can help mitigate risks to a certain extent. An investor should spread investments across industries or asset classes instead of putting all the eggs in a single basket. Portfolio diversification can help in trimming losses as while one sector might be facing some challenges the other one may make up for losses. The diversification strategy protects an investor from several negative events in the market.

Use stops and limits order to manage risk

Stock markets are usually volatile and a risky asset class. Finalising the entry and exit points before the start of trade is the key to managing risks in this asset class. An investor should use various stops and limits orders to manage risk while investing. Stop order helps in closing a position in case the market turns negative. As there is no surety about how down a stock or market can go, investors must set a price below which he or she will not face loss.

Similarly, limit orders will chase the profit target if the market goes upward. Limit orders close your position when the price targets are achieved.

Follow money mantra of 1% position sizing

Successful traders follow this money mantra to limit risk in an asset. The position sizing rule suggests that an investor should not put more than 1% of the capital into a single trade. Rather investment should be made in small amounts. For example, if an investor has ₹10,000 in the trading account, the investment in one asset should not be more than ₹100. The remaining money acts as a buffer against volatility. As each asset has distinct risk factors, adjusting the position sizing strategy can create a balance between the risk and the investment.

Hedging

Hedging means the use of various financial instruments like futures or options to cancel out potential losses. While creating a position in an asset, an investor can open another position in the same asset in the opposite direction such as purchasing put options can protect against potential price drops.

Active Portfolio Management

An investor should always keep monitoring and changing the portfolio on a constant basis. There should always be an eye on market and general news development that can affect the investment in a particular asset. Market trends, economic data and corporate performance should be tracked regularly to avoid losses.

To sum up

In addition to these strategies, there are numerous tools that an investor can deploy to cut losses in adverse market conditions. Strategies such as stop loss or setting the maximum loss limit that an investor is willing to accept, risk-reward ratio, which means knowing the risk against the reward can help limit market risks.