Risk Management Trading in the Stock Market can be richly rewarding but it's also froth with a great degree of risk.
In order to navigate the shark infested waters that is the Stock Market, a meticulous Risk Management plan is needed.
Trading and investing should not be left to fate.
No matter what your trading strategy is, financial risk management is an absolute prerequisite in order to be profitable.
There are many methods that can be utilized to assist in effective Risk Management Policy.
Some are more successful than others.
Some as well cost more than others.
A few of the more effective ones are Diversification, Options and Stop Orders.
Diversification Diversification is a major tool in security risk management.
Restrict the size of one position to not more than 5% of your portfolio.
Even if you get wiped out totally in that position, the result in your portfolio is going to be negligible.
Diversification should not only involve how many stocks you have in your portfolio.
It ought to involve separate sectors and countries as well.
Diversification should include US and Global stocks as wells as ETFS.
Another Risk Management Tool Is Options Options can be utilized for flat out speculation, as a trading vehicle or as an investment hedge.
Whenever you use it as a hedge, you would buy the equity as well as an accompanying Put.
Instead, you can buy the stock and sell a Covered Call.
Both of those techniques, buying a Put or selling a Covered Call, have their benefits and disadvantages.
The benefit of buying the Put is if the stock loses value, the Put Option will be gaining in value to substantially compensate for the damage to the stock's price regardless of how far the stock falls.
One shortcoming, and it's a small one, is if the stock increases in price, you lose in the value of the Put Option, but your lost is restricted to how much you paid for the Put Option.
An added drawback is if the equity price moves nowhere after buying it, the Option loses value as time passes.
Having a Covered Call on the other hand, if the stock price goes nowhere after buying it, you still will generate profits on the Covered Call.
Remember you sold it and as the price declines that is to your advantage.
The Covered Call also provides some partial protection if the stock goes down, but it's protection is restricted more or less to the price of the Option.
If the stock pulls back further than that, you are not protected.
Also, if you sell Covered Calls, you cap your upside profit because as much as you gain in the price of the stock you will be losing with the Option.
It is important to be aware of that if you purchase an Option, your gain is so far as the stock price could go.
In the case of a Put, it can gain as the stock price pulls back all the way to zero but a Call is limitless.
Well at least that's the theory, but we know that stock prices will not go all the way to the moon and gravitation shall catch up sooner or later.
Keep in mind, this is not a lesson about Options and whatever mention of them is brief and restricted to the scope of these discourses.
Another Risk Management strategy is the use of Stop Orders