Risk Management
What is risk management?
You might think risk is either something you’re prepared to take or you’re not, but investment risk is much more intricate than that. Investment risk tends to be graduated.
Levels of risk can change, are influenced in different ways, and will come to bear at different times. So experienced investors plan a portfolio around this using a risk management strategy.
Where have you heard about risk management?
Risk management procedure is an essential part of an investment strategy.
Financial advisers talk about risk management with their clients as part of portfolio planning. Corporate investors use analysts and sophisticated modelling to evaluate and manage risk.
What you need to know about risk management...
To manage risk first you need to work out what you want to gain and what you can afford to lose, and over what timeframe. Then, analyse the variables that might limit your returns or lead to losses, and identify any potential risks in your portfolio. Risk management is working out how to mitigate against these risks.
Variables that can impact on risk include economic slowdown, financial difficulties within companies, commodity supply and demand, and interest rate changes.
You can limit risk by doing your research to understand the factors that influence the markets you're trading on and by carefully monitoring market conditions. Try to avoid sentimental trading and giving in to herd mentality.
You should know how much loss you can afford to take overall and on each trade, and don't let yourself go over these limits. You can use tools like stop loss orders and limit orders to protect yourself in volatile markets.
Another common risk management tactic is to hedge against a variable outcome. For instance, an investor might see if any derivatives are available that would give a return if prices go another way. Or they could adopt a mix of long and short positions.