There are great opportunities to make money in the stock market through investments and trading. You are subject to risk, regardless of what relationship you have with the stock exchange - whether you're an investor who makes SIPs or a day trader who trades multiple times per hour, there is a potential for you to make money in the stockmarket. Your environment is influenced by the structure and nature the market in which you trade. This is a different story.
This is called risk management. Before you even consider investing a rupee in the stock exchange, it is important to be familiar with the best risk management strategies that traders and investors use worldwide. These are the key principles to incorporating into your daily trading and investment routines. We'll be looking at them soon.
Let's first look at three important aspects of stock market risk management. Recognizing that there is some risk is the first step in risk management. The second and third steps in risk management are to identify the source of the risks and manage or mitigate that risk. This sounds complicated, but let's look at some examples to help you understand it better.
Sharad recently spotted news about a recent IPO while looking through the news. The news reported that the company traded at three times the IPO price in the first two days after it was listed. Sharad, a newcomer to the stock exchange, decided to subscribe for the next major IPO using his savings and make quick money. He also wanted to be able to exit quickly. Can you see the risks in his plan?
You may have been trading for some time or are learning about trading, and you might be concerned that you could end up spending all of your savings on the stock market. Secondly, Sharad may be concerned if the stock market goes down following the listing day. Thirdly, is it right to invest all of your savings in the stock of a company just being listed on the exchange
Sharad's plan does not seem to be risk-proof. This sounds very risky. You might face other risks, so acknowledging them and identifying them is the first step in staying safe in the stock market. These are three mantras to remember when making stock market moves.
Diversify It's not an exaggeration to say that we have said this for the fourth time. Even experienced investors can sometimes jump ship when they see lucrative opportunities in stock markets. You should not invest all of your money in one stock or in one industry sector. Diversify and place your money in different places: mutual funds, blue-chip companies, debt instruments and, if you're experienced enough, money markets and commodity market might expand your horizons for diversifying.
You can sometimes micro-manage the risk of every position you make in the market. Stop losses and sell targets are used by some traders to time their exits and determine their maximum losses before placing an order. Diversification strategies will inadvertently be linked to your risk appetite, your fund size, and your growth goals. Diversification, regardless of what variables affect it, is one the most fundamental risk management principles in the stock market.
Use rupee cost-averaging. We recently discussed how skilled traders time their trades accurately. One example is buying at the bottom and then selling it around forecasted or established resistance bands. If you're an investor looking to grow over the long-term, rather than spend time perfecting trade math, rupee cost-averaging may be the best option.
This approach requires you to purchase shares frequently - not all shares will be the same price. The long-term average buy cost will be low, but what will make this approach stand out is the compounding growth of small investments.
Finally, you can offset your losses. Sometimes things don't go according to plan and traders end up with trades that are in the wrong direction. Stop Losses, which limit the loss by selling your shares automatically if there is a limit to your share price, are a great way to cap your losses. You can also offset derivative trading losses by paying attention to taxes.
Your tax advisor can help you get more money if they are smart enough to offset your Futures and Options trading losses by allowing you to offset them against a non-speculative income component. This highlights how important it is to have a skilled tax advisor by your side to manage stock market risks beyond stock markets. Remember, derivative trading losses can be carried forward up to eight years.
These are just a few ways to manage your risk when trading in the stock exchange. Some of these strategies might be applicable to you. Others might not. Take diversification as an example. While diversification is beneficial, you should also consider which markets are moving in a similar way in the stock market. Before making any decisions about your portfolio, ask these questions.
Stock market risks shouldn't stop you from tapping into the immense potential of every trading session across all exchanges worldwide. Learn the basics of managing risk in stock markets and you can enter the market like an expert!