Lesson 4: Don't Understand The Risk

 

Lesson 4: Don't Understand The Risk

Risk is one of the most important factors to consider when trading. Everyone has a different tolerance for risk. If you are a long-term trader and the market has fallen by 20%, can you calm down and survive the plunge? If not, you may wish to diversify to add bonds to your investment.

Are you investing in more than one pair of stocks? If you do not properly diversify your investment, you will take a lot of risk and should be spread across many different stocks, not just a few stocks.

If you are a trader, do you limit your capital exposure by using stop losses and sufficient risk for each transaction? As far as the risk of each transaction is concerned, many traders determine their maximum risk, and will not assume more than that maximum risk for any stock. For example, the risk of many traders in a single transaction does not exceed 1% of their total investment portfolio capital. This means that you will add a stop loss and sell any positions that fall by more than 1% of your total portfolio (1% risk per transaction). For example, if your account balance is P 100,000, you will not risk losing more than P1,000 in any transaction. If you buy P 100,000 of Jollibee stock and the price of your position drops to P95,000, you will sell your position to avoid an additional loss of more than 1% of your capital.

By limiting the percentage of portfolio loss for a transaction, you can avoid huge losses in any transaction. Proper risk management can determine the success or failure of the stock market.

Lesson 3: No Strategy

Whether you are a long-term investor or a trader, developing a strategy is the key to your success. Investors and traders have different strategies. Here are a few important strategies to remember.

Long-term Investor Strategy

Pesos Average Cost

Pesos average cost is the process of investing a certain amount of capital each month regardless of market changes. The average cost of pesos helps investors obtain higher returns during a bear market and reduces the volatility of overall returns. In the table above, if you have the average cost of pesos in 2015, your return will be greater than 3.26%. We'll talk about it later in our succeeding series of this blog about averaging and different types of strategies in which averaging is one of them.

Diversification

Diversification is the process of buying multiple shares instead of buying a single share. Building a diversified equity portfolio is important because the stock market is unpredictable. If you buy a stock, the company goes bankrupt or performs poorly, you may lose a lot of money. Conversely, if you buy ten stocks and one of them fails or performs poorly, you have nine or more stocks to rely on. Diversification to diversify your investment risks.

Trader Strategies

Develop a Trading Plan

Your trading method will depend on your risk tolerance, your personality, the amount of money you can invest, and so on. Because every operator is different, it is important to develop a business plan that you will stick to. The trading plan should include everything from the maximum allocation of your investment portfolio and the risk of each transaction to your preferred risk/reward ratio.

Win Rate

As mentioned above, a healthy win rate is an important strategy for traders. Of course, it is difficult to increase your profit margin, but if you plan your trading strategy and the technical indicators you follow, you can maintain a constant profit margin through a suitable strategy. All other things being equal, traders who profit from 25% of trades will do better than traders who profit from 50% of trades but have a lot of losing trades.

Risk/Reward Ratio

The risk/reward ratio is closely related to the winning ratio. If you can create a healthy profit margin and a healthy risk/reward ratio, it can help you become a successful trader. For high risk/reward ratios, you can pair trades with high-profit potential with suitable stop losses. By limiting the amount you can lose while increasing the amount you can earn, you can make huge profits through trading. Combine a high rate of profit with a high rate of risk-return, and you can become a trader.