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.