Risk Management In The Stock Market is Part of Investing 101

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Risk management is often overlooked by people when investing in stocks. This is especially the case when referring to beginners. Investors should always focus on this though, as it is an important part of investing 101. It is impossible to control market direction. The only thing you can control is how much loss you would suffer if the market moves against you.

Risk Management In Stocks

In most cases, risk management is all about setting the stop signs. Unfortunately, so many investors will not even do that. The problem is that risk management in stock trading is so much more complex. What is very important is to have a set of rules in place so that you would be able to make risks as small as possible. Obviously, some investors will want to expose themselves to more risks when there is the possibility of making a higher profit but for beginners this is always a bad idea.

Discipline In Financial Market Investment

Analyzing risks before investing or trading is a must. You basically have to look at current market environment, trends and how secure the trading environment is. Is there a danger spot that would stop you from making a successful investment?

Let’s suppose that we are looking at a bearish market and a company released news of disappointing earnings. Would shares be bought simply because there is an increase in price value? There is a good possibility this would not be a good idea. A short term profit can be obtained at a really good rate but the risk is high.

risk management in the stock market.
Risk Management In The Stock Market.

The good news is there are various risk management techniques one can use. Here are some to consider.

Frequency

Frequency in this context means how many open positions exist at one time. Most investors will simply try as many options as they have, even if success margins are low. That happens as there is a fear of missing a good trading opportunity.

What you should understand is that the best thing you can do is to be selective as you open the positions. Just take the trades that meet specific criteria.

New investors are recommended to drastically limit the number of open trades since it is practically impossible for them to properly track them all.

Duration

Duration refers to how much time is spent in one trading position. If you spend too long, you have an increased possibility of adverse price movement. Stock market investors are actually faced with more risk the longer the duration. A smaller time frame chart will bring in a lower profit potential but the risk will also be a lot lower.

Trading Volume

In risk management, volume is by far the most important thing to consider. This means share size that is taken per one traded position. You will want to profit as much as you can but when a larger share size is taken, risks are higher. Be sure to practice volume based trading in simulated accounts until you find your own recipe for success.

Volume is the most important aspect to your risk management plan. Volume for a trader/investor is the share size we take per position. Obviously, most people want to profit as much as possible, but by taking a larger share size, we also increase our risks. Volume should start as practice, in a simulated account, with no money at risk. After successfully practicing you may increase your risk with minimal shares. If you keep doing well, gradually increase your share size.

The key word in the last sentence is gradually. Many traders feel they must go from 100 to 1000 shares, or 1000 to 10000 shares. Each step increases your risk ten times! You are much better off by no more than doubling your share size or risk for every step and only do so if you are achieving a positive win/loss ratio.

When you risk more money in a position, there is a psychological effect that you will notice. Watching profits and losses increase exponentially can wreak havoc on a new trader’s psyche. This may cause you to panic and exit positions too soon or to hold onto losers as you become frozen with fear.

If you are not trading or investing well at any time, you should immediately examine your risk management. The first thing is to reduce your volume (share size). Secondly, be more selective in your positions and turn down the frequency. Lastly, you can also reduce the duration of trades to offset volatility.

Everyone has a different balance of these risk management tools that they should be using.

The courses at Online Trading Academy teach you proper risk management. Once you have completed them, you will work individually with your local center’s student support specialist as well as your educational counselor to find the right balance for your specific situation and trading plan.

Until next time, may all your trades be green and your losses small!

Boris Dzhingarov is a business writer who investigates issues to craft great stories that readers love.