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4 Ways to Reduce Investment Risk

While trading in the stock market might seem appealing, it does have its risks. You’re placing your money in investments where generally you don’t have much control. In addition, stock markets have a reputation for being volatile. One news event or economic policy decision can alter your chosen stock’s trajectory. You could find the stock you’ve chosen plummet. Keeping these things in mind, traders must ensure they’re minimizing their risks by making prudent decisions. 

According to the United States Securities and Exchange Commission, most day traders suffer several financial losses when they initially start trading. Moreover, many never manage to make profits. Therefore, the SEC encourages day traders to be aware of the risks before starting. Likewise, swing traders often fare a little better than day traders. However, the truth’s you’ve got to make sure you’re investing your dollars sensibly. 

Hence, risk management plays an integral role for many traders. Many traders will endlessly try to develop techniques and strategies to reduce their risk when trading. Let’s explore them in detail.

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Alt-text: Traders developing risk management practices

Ways to Reduce Investment Risk

Here are some ways to reduce investment risk. They include:

Do Your Due Diligence

It’s generally good practice to conduct due diligence before doing anything related to your finances. Whether it’s investing or spending, you should always ensure that you’re using your money wisely. However, when you’re thinking about purchasing stocks, due diligence is paramount. Moreover, blindly investing in a stock based on recommendations will more often than not lead to losses. If you’re considering trading or investing in a stock, you’ll want to make sure to do fundamental analysis to get a better understanding of the company’s past performance. Moreover, performing fundamental analysis also gives you a better idea of the direction the company’s heading. You’ll want to run several tests to examine things like a company’s debt-equity ratio, PE ratio, etc. 

Diversify

It’s not uncommon to hear about traders choosing a similar set of stocks. Everyone has their area of expertise. You might know the ins and outs of a particular industry better than other people. However, if you’re only trading in one industry, you’re leaving yourself open to risk. For instance, let’s assume you like to trade retail stocks. You might have actively been trading retail stocks to great gains previously. However, since the pandemic arrived, retail stocks have been declining steadily. Therefore, you’ll have suffered significant losses if you were only trading retail stocks. Hence, it’s crucial to diversify your trading portfolio by choosing various industries.

In addition, you’ll also want to diversify by investing in small-cap and large-cap companies. Typically, when a market crashes, small-cap stocks plummet quicker than large-cap stocks. Diversifying your portfolio doesn’t eliminate risk. However, it reduces your overall risk, leaving you in a safer position with your investments. 

The One-Percent Rule

You’ll often hear many fellow day traders talk about the one-percent rule. If you’re not aware of this rule, you need to know about it now. The one-percent rule dictates that you should never put more than 1 percent of your investment into a single trade. Generally, this rule applies to traders with less than $100,000 in capital. However, some traders will stretch the boundaries of this rule to 2 percent, provided they can afford it. 

To illustrate this point further, let’s take the following example. You’ve got $10,000 ready for trading. You spot an opportunity for a quick profit. Following the principles of this rule, you’ll only utilize $100 for this trade, even if you know it’s going to be successful. 

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Alt-text: A trader tracking stock movements on their smartphone

Set Stop-Loss and Take-Profit Points

Setting stop-loss and take-profit points enable you to reduce your risk. Typically, traders like to hold onto their stocks. They believe their stock will eventually rebound, leading them to recoup their money. However, more often than not, adopting such an approach results in traders losing more money than anticipated. Setting a stop-loss price helps negate this issue. Let’s assume you’ve purchased a stock at $20. You set a stop-loss price at $18 while setting a take-profit price at $24. You expected to profit from the trade because you forecasted the stock’s price to reach $25 by closing time. However, things don’t play out the way you’d planned. Instead, the stock falls to $18. Since you’ve set a stop-loss price, you’ll try to minimize any further losses you might take. Hence, you’ll sell the stock and seek new opportunities instead. You’ll try to recoup the losses you made on this deal with future deals. However, you won’t try to hang onto your position, hoping that things will turn around. 

Likewise, in this example, if the stock’s price rose to $24, you would sell it. Traders will usually do this when they anticipate a stock is reaching a resistance level where consolidation will occur. 

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Alt-text: A trader analyzing stock prices on their smartphone

Reduce Risk with Stocks of the Day

Stocks of the Day is an online AI-powered news ticker website. It’s also one of the best stock news platforms for day traders and swing traders alike. Stocks of the Day provides daily stock market news and coverage. In addition, it also has a stock market news RSS feed for traders and investors. However, what sets Stocks of the Day apart from competitors is their AI stock predictions. Investors are unlikely to find more accurate stock predictions anywhere else on the internet.

Visit their website today to learn more. Alternatively, you can consider signing up for a free 7-day subscription to check out other features they’ve got to offer.

About The Author

Arthur Francoise is a retired financial analyst. He spent decades working for some of the top hedge funds in NYC. During his illustrious career, Francoise managed 9-figure funds. Today, Francoise is affiliated with Stocks of the Day.