Risk is an integral part of our lives. Taking risks, not taking risks, everything depends on the choices that we make. However, not taking risks is the biggest risk that one can take.
The relationship between risk and return is powerful in the stock market. Right practice in risk management helps cut down on losses and gives a hint to the traders about the future market trends. After all, a trader who has generated substantial profits can lose all of it in just one go without any proper risk management strategy.
Planning your Trades:
Having a trading plan helps traders to easily trade in the markets as the parameters have been pre-set.
Planning about trades helps in understanding when you should take profits and cut losses, which can help taking emotions out of the decision-making process.
With a plan in hands comes discipline to follow the same. You could discover why certain trades work and others don't.
It also helps you to learn from your past trading mistakes and improve your judgement for future transactions.
It is crucial for a trading plan to have the following parameters:
- Motivation for trading
- Time commitment
- Trading Goals
- Attitude towards Risk
- Availability of Capital
- Markets you want to trade
- Steps for record-keeping
The one-percent rule:
One of the effective risk management strategies is the "1% risk rule". Adherence to this rule keeps the capital losses to the minimum when a trader experiences harsh and unbearable market conditions. This rule limits the risk on any given trade to no more than 1% of a trader's total account value.
It is feasible for traders to risk their 1% of the capital by trading either large positions with tight stop-losses or small positions with stop-losses placed far away from the entry price.
It is impossible to win every trade, and the 1% risk rule helps to protect a trader's capital from declining significantly in unfavorable and unavoidable situations.
This rule can be used while trading in stock market or other markets such as futures or forex. This method allows you to adapt to every market conditions, whether volatile or sedate and still make money.
Calculating Expected Returns:
The level of risk associated with investing in the markets typically correlates with the level of return that a trader might achieve.
The purpose of calculating the expected return is to provide an investor with an idea of probable profit versus risk.
An expected return is calculated by multiplying potential outcomes by the odds of them occurring and then totaling these results.
It is a tool used to determine whether a trade has a positive or negative average net outcome. It is typically based on historical data and is therefore not guaranteed into the future, however, it does often set reasonable expectations.
Effectively set stop-loss and take profit points:
Stop-loss helps traders from losing too much of their investments in one trade. Take profits, on the other hand, helps traders to lock-in what has already been earned.
It is significant because the market is unforeseeable. At one point it is going pretty well and at the other point the market is bearish. The factors supporting the bearish markets can be fundamentally or technically analyzed but till that time the trader might have faced all the losses.
Diversification and Hedging:
Diversification helps in maximizing the returns by investing in different areas that would react differently under similar situation. Although it does not guarantee protection against the losses that might incur, diversification is the most important component of reaching long-range investing goals, while having the potential of minimizing the risks which are unforeseeable.
Hedging helps traders and investors to mitigate risk and volatility by minimizing the risk of loss. By holding uncorrelated stocks in a portfolio, overall volatility is reduced. In simple words, traders hedge one investment by making a trade in another in order to balance out the risk and reward parameter of the market.
Conclusion
In order to trade for long term it is critical for a trader to learn and understand all the strategies about risk management required to trade in the stock market. Managing risk, involves various calculations of market risk and fluctuations. By using the following strategies, the trader can not only minimize losses but also exit a trade as and when it is required. It is also important to have experts guidance while trading in the stock market in order to understand the above stated strategies. Get research-based trade recommendations and be a responsible trader.
Happy Investing!
