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How to Manage Risk in the Stock Market
What is Risk Management?
Risk management is the process of measuring, or
assessing risk and then developing strategies to manage the risk while
attempting to maximize returns. Typically involves utilizing a variety of
trading techniques, models and financial analyses.
The potential return from any investment is
generally depending to the amount of risk the investor is willing to assume.
Investors will not take on greater risks without
the possibility of higher earnings. This is called the risk premium.
Common types of Risk
There are two common risks that investors should
notice them well:
Market Risk: The possibility that the value of
financial markets rise or fall.
Inflation Risk: The risk that rising prices of
goods and services over time, Inflation risk is also known as 'purchasing-power
risk' and it is one of the most important factors for long-term investing.
You can't control the inflation risk, but with a
good strategy you can manage and control the affect of market risk on your
stocks.
A professional trader always tries to understand
and control portfolio risk. Before entering into any trade, good traders first
think about how much risk to take and how much risk exposure comes with a
particular trade selection. Only then do they allow themselves to think about
how much profit they stand to make.
Prudent investors always close their position and
exposure if they determine that a portfolio carries too much risk.
Risk Management for a Trade
1- Before you decide to trade consider to these
fundamental principles:
2- Before you trade a stock, know how much you
are willing to lose.
3- Check the stock to be sufficiently liquid, can
you buy or sell promptly?
4- Determine the cut-loss level before trading.
5- Determine your profit target
(take-profit-level).
6- Buy the stock only at an acceptable price
level. Use a limit order when you buy a stock.
7- Immediately after the trade has been
confirmed, enter the stop-loss-at- market order at your predetermined stop-loss
level.
8- Take profit when the trade reaches your profit
target.
For example: so many traders determine their
cut-loss level 2% of their capital and they call it 2% rule. If you own 1000
shares of X at $100 with a $2 stop loss order in place, your risk is: $2 * 1000
= $2,000. So long as you have capital amounting to at least $100,000 on hand,
you would not be considered to be in breach of this "rule".
Portfolio Risk Management
Whit managing the risk of each trade your
portfolio risk will be well under control and you manage your portfolio risk
actively, but to control your portfolio risk management better notice to this
pointes:
1- Determine your overall cut-loss level. Usually
your portfolio should not lose more than 10% of your capital.
2- Diversify your investment in at least six or
more different stocks.
3- Know your overall risk tolerance before
building up the portfolio.
4- Act quickly when you see your risk limits
exceeded.
5- Close out the entire portfolio if it loses to
your overall stop-loss level.
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