Employ Risk Management Strategies

With any investment, be it stock trading, real estate or business, it is important that you understand what the risks are and how to minimise your exposure to these risks. This process is known as 'Risk Management'.

The Three Elements Of Risk Management

1. Spread Your Risk: Don’t Put All Your Eggs In One Basket
Spreading you risk is as simple as not putting all your eggs in the one basket. This is called diversifying your portfolio.

Spread your capital so there is never more than 20% in a single stock.

Don’t however take this to extremes and over-diversify by investing in too many stocks at once. You cannot expect to outperform the market if your portfolio closely matches the market. A rule of thumb is to limit your portfolio to between 5 and 10stocks.

2. Plan Your Exit: What Is An Acceptable Risk?
Amateur traders buy a stock and their focus is to hope it increases in price. If it goes down, they continue to hold in the hope the price will recover. When a professional buys a stock they recognise that success is a probability, not a certainty. At the time of entering the trade they establish an Early Exit price. If the stock falls past this point the good investor will immediately exit and never run the risk of making a large loss.

Maintaining your capital is fundamental to successful trading. If you invest in a stock and make a large loss, then it is impossible to consistently profit from the stock market. Having incurred a large loss, you must now make a large profit just to break even. The key to successful trading is keeping your losses small.

3. Stop The Loss: Don’t Drive Without A Seatbelt
The second must sell signal is a Stop Loss. Just tracks the highest price reached by the share since purchase. If the share falls by more than 10% from this price, it is time to sell. We suggest 10% - you can change this depending on your trading style. Too small a percentage and it will get you out too early. Make the percentage too large and you give back too much of your profits before exiting. Start with a 10% fall and see what you feel comfortable with.
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