Risk in investing comes in many forms and in different flavors. One stock trading risk that is often brought up as an issue is that of loss of capital. What exactly are this risk and how does it affect the way a stock trading investor approaches his or her investments? Risk in stock trading is any potential loss which might result from one or more factors. Some of these factors are called credit risk, price risk, time risk and market risk. It is possible to have all three of these levels but only a very small percentage of stock traders are exposed to all three at any given time.
The best way to avoid all risks is to perform proper risk management. There are three areas that must be considered: interest income, asset value and the realized gain or profit on sales. All three are important but interest income should not be given the least attention since it has no direct relationship to the losses. On the flip side, the profit on sales represents the gains and losses realized on sales.
Proper risk management
In today’s stock trading environment, the need for proper risk management is especially important. Many investors are overly focused on short term gains rather than long term ones. This is because the gains can be so profitable that it is easy to overlook the longer term trends. Instead, the investor focuses on the current gain and forgets about the future.
For this reason, an investor must be well versed in risk management. To perform this task effectively, the investor must have a good understanding of risk tolerance. One indicator of a good risk tolerance level is the amount of cash that can be lost without significant impact on overall income. The better the risk tolerance, the greater the investor’s profit potential without experiencing significant losses.
There are several tools available to gauge risk tolerance.
The first is to use the historical volatility level of the price of the security and compare it with the historical volatility level of the market for similar stocks. Using this information, the investor can determine how much risk is associated with future losses. Obviously, the larger the loss, the greater the risk tolerance required.
Another risk management tool is to diversify by adding other types of safe investments into the portfolio. One of the simplest ways to achieve this is to add bonds into the portfolio. A bond generally offers a lower return on investment than most other stocks, but it also offers higher interest stability. This type of risk management strategy is important when an investor does not have enough money to purchase or trade all of their stocks.
Lastly, it is important to keep track of risk by using software designed for stock trading. These programs are designed specifically to recognize high risk stocks and minimize their impact on the overall portfolio. By keeping track of the software’s findings, the investor can reduce the frequency and magnitude of stock market fluctuations and increase their overall safety. Software designed for risk management can help even the novice trader to stay on top of the action during stock trading.
In Conclusion
Managing risk is just as important for non-traded areas as it is for trading stocks. In areas such as real estate and the financial industry, risk management is even more crucial. Real estate investment and lending are not easily predictable, and when disaster strikes, the losses can be catastrophic. The same is true of the financial industry: A major investment could collapse tomorrow, leaving those left holding the bags responsible. While there are no guarantees in investing in stocks, those who properly manage risk can minimize their impact on portfolio equity.
