The stock market carries a great potential for earning money through trading and investments. No matter what relation you share with the stock market – whether you are simply an investor who makes SIPs in the stock market or an intense day trader who places multiple trades every hour, you are exposed to what is called risk. The structure and nature of the market you trade in determines the risk factors that are embedded in your environment. How you deal with these risk factors is another story however.
The latter, is what we call risk management. Before you invest a single rupee in the stock market, you must arm yourself with some of the most solid mantras of risk management that investors and traders play by globally. What are these techniques, and how can you bring them into your everyday trading or regular investment practice? We will take a look at them shortly.
But before we get started on that, let’s take a look at three crucial aspects of risk management in the stock market. One of the first steps in risk management is acknowledging that there is some degree of risk in the first place. The second and the third steps are identifying the source of risks and managing or mitigating that risk. Sounds fancy, but let’s take a look at some examples to understand this a little more clearly.
Recently, Sharad was flicking through the news, and spotted some news about a recent IPO. According to the news, the company was trading at 3 times the IPO price within 2 days of listing. Being new to the stock market, Sharad decided to subscribe to the next big IPO by utilizing his savings, making some quick money, and making an exit within a short span of time. Can you spot the risk in his plan?
If you have been trading or learning about trading for a while, then you will be quick to raise two concerns – first, utilizing all your savings to invest in the stock market is a bad move. Secondly, what if the next IPO that Sharad is planning for, goes down after the listing day? And thirdly, does it sound right to lock up all your savings into the stocks of a company that is just being listed on the exchange?
Sharad’s plan is actually not risk-proof. On the contrary, this sounds like a very risky plan. There might be other situations where risk can emerge – acknowledging and identifying that risk is the first big step to staying safe in the market. To manage these risks, here are 3 mantras that you should remember before making a move in the stock markets:
Diversify, diversify, diversify: It won’t be an overstatement if we said it for the fourth time. Looking at lucrative opportunities in the stock markets, sometimes, even experienced investors jump the ship. Never put all your funds in a single company’s stock, a single industry sector, and even in a single market. Diversify, and put your funds to work in multiple places – mutual funds, blue chip companies, debt instruments, and if you are experienced, then money markets and commodity markets might further expand your horizon for diversifying.
Sometimes, you can even micro-manage risk of each position you take in the market. Some traders make efficient use of stop losses and sell targets to precisely time their exits and know their maximum potential losses before creating an order. Your diversification strategy will be inadvertently linked to your risk appetite, the size of your corpus of funds, and your growth expectations in line with your financial goals. No matter what the variables affecting your diversification strategy, diversification is one of the most basic risk management mantras in the stock market.
Practice rupee cost-averaging: We were recently discussing how experienced traders time their trades precisely – an example of this is taking a long position by buying near the bottom, and selling it around established or forecasted resistance bands. But if you are an investor who simply wants to achieve regular growth over the long term rather than spending time perfecting the math of your trades, that rupee cost averaging might be your best bet – the concept is pretty simple.
All you need to do in this approach is to buy shares regularly – some of these shares purchased by you will be cheaper than others. Over the long run, the buy costs will average out, and what will stand out is the growth of these small, compounding investments.
And lastly, offset your losses: Sometimes, things don’t go as planned, and people do end up seeing their trades go in the opposite directions. Stop losses, which cap the amount of losses by automatically selling your shares if a limit of drop is reached, are an excellent means of capping your losses. But you can offset your derivative trading losses too, by paying attention to your taxes.
If your tax advisor is smart enough, they will offset the losses you incurred on your Futures and Options trades, by offsetting them against a non-speculative component of your income, thereby helping you land more money in your pocket. This also highlights the importance of having a smart tax advisor on your side to manage your stock market risks beyond the stock markets, and in the long run – remember, losses from derivative trading can be carried forward for eight years.
So these are a few strategies that can help you manage risks while dealing in the stock market. While some of this advice might apply to you, others might not. Consider the point of diversification, for example. Yes, it is beneficial to keep your funds allocated to different market segments, but which industries move in a correlated manner in the stock market? Ask such questions before making conclusions about your portfolio.
Anyhow, stock market risks should not deter you from tapping into the vast potential that resides in every moment of trading across exchanges globally. So go out there, master the principles of managing risk in the stock markets, and enter the market like a pro! For information on managing stock market risk, check out our other articles, or visit www.angelbroking.com.