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.
File-Name: Risk Management
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 is common 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 are putting all your money in one form of investment, you might be leaving yourself open to risk. Therefore, it is advised to avoid putting all eggs in one basket and diversify your portfolio to the maximum extent possible. Some common ways to diversify your investments include buying and renting properties with the support of real estate companies Macclenny (or wherever you live), investing in mutual funds, or backing startups and becoming an investor.
Along with that, investing in precious metals has always been a worthwhile investment path to consider, and as long as you understand the rules and regulations, you will be able to stride to great lengths and increase the amount of money that you generate through your investments. You can further secure your investment by opting for a reliable seller who can have various laws and security measures set in the buyer’s favor. Companies like GSI Exchange and a few others can have a clear guide for investors to purchase and sell gold and other precious metals, which you can learn by searching ‘how does gsi exchange work‘ on the internet. Accurate information can help you be more aware of investment options and risks related to them.
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 more 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.
File-Name: Stock Prices
Alt-text: A trader analyzing stock prices on their smartphone
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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.