Stock investing is characterized by a strong risk-return correlation. High risks mean greater returns and vice versa. Risk management is the act of identifying and assessing the potential risk and developing strategies to minimize these and earn maximum possible returns.
Risk Management Strategies
Following Market Trends:
Many investors believe that investing against the market trends can yield them higher returns. However, following the trend is one of the most important stock market strategies to mitigate investment risk. The difficulty in this strategy is being able to identify the trend because the markets are dynamic and constantly changing. Being able to spot the short-term trends within the longer duration is a difficult task.
Diversifying Investment Portfolio:
The stock market provides investors several financial products, such as equities, bonds, derivatives, and mutual funds. Investors can opt for more than one of these financial instruments to diversify their portfolios. Further diversification can be achieved by including financial products offered by different companies belonging to distinct sectors. This protects the overall returns from the investments from market fluctuations and if a specific sector or company moves in an unfavourable way, the other investments in the portfolio can achieve the balance within the investors’ portfolios.
Being Patient and Avoiding Quick Decisions:
Several investors make quick and hasty decisions with every small movement in the price of their investments. Moreover, another stock market tip that investors forget to adhere to is taking the time to do their research and due diligence before making their share market investment decisions. Determining the financial objectives prior to investing and focusing on both short-term as well as long-term objectives will help investors enjoy maximum returns on their stock market investments.
Planning the Trades:
Planning and developing the strategy helps win wars. This is true for investing in the stock market too. Pre-planning can make all the difference between success and failure through stock investing. Using stop-loss and take-profit points are useful instruments in planning the trades. Successful investors pre-determine the entry and exit price levels to calculate the possible returns against the potential of the shares hitting these price levels. On the other hand, unsuccessful traders make investments without considering the prices at which they will buy and sell the financial instruments. They often trade with emotions; they continue holding on to their positions even when the price decreases, in the hope of a turnaround, and fail to book profits when the price rises with the greed of making higher profits.
This is the lowest price that the investor is willing to sell and prevent further loss. Setting a stop-loss point is useful when the market does not move as per the investor expectations. It is beneficial in preventing the ‘price will come back’ mentality and limiting the loss on the investment.
This is the price at which the investor is willing to sell his investment and book profits. This point is beneficial to reduce the risks when the possibility of further price increase is huge. Booking profits on stocks that are nearing their resistance levels after large gains ensures that investors sell these before consolidation occurs and prices begin to decrease.
The stock market is risky and smart investors take advantage of risk management strategies to mitigate it. Careful and timely use of various risk mitigation tools ensures investors can maximize profits through stock investing.
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Credit: NYSE, The Wall Street Journal, Forbes
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