Rules of risk management - By D. Mohini

Rules of risk management
Some principles to keep your trading risk at the minimum level


The stockmarket is a place where more investors lose rather than make money. However, losses can be reduced or
even eliminated by following some simple principles of risk management. We will discuss a few of these below.
These principles apply equally to anyone who is already trading in the market, or is thinking of doing so.
The first one goes against the mindset of most traders, as they get into a trade thinking only of the profit they
would make on it. The rule is to not think of the profits you can get out of your trades, but only of the losses. It is
much better to plan your reactions to a loss before entering into the trade. Decide on what you would do if the
stock goes against you, losing 5%, or 10%, or even 20%. It is better to assume that the market is going to go against
you when entering into a trade, as you are then prepared to face the eventuality.
The second principle is to use a stop loss. Most professional traders employ stop losses between 3 and 7% of their
entry price. A stop loss restricts your loss to an acceptable amount. Placing stop losses can now be done through
the stock exchanges’ ordering system. Stop losses are a vital part of trading. Even the world’s most successful
traders expect more than half their trades to wind up with a loss. It is therefore critical to keep losses at a
minimum on the unsuccessful trades. Here’s an example of a stop loss – you buy a stock at Rs. 200 and decide to
use a 5% stop loss. This means that you wish to restrict your loss on the trade (if it goes against you) to 5% of your
entry price, i.e. Rs. 10. You would then place a stop loss below Rs. 190. This means that your stock will get sold if
the price of the stock falls under Rs. 190.
Next, don’t enter the market without a clear plan. Following a tip does not constitute a plan. The plan must
include your reason for picking a stock, your stop loss and your exit strategy. Picking an exit is not easy, but should
nevertheless be planned in advance. One simple strategy is to use a trailing stop on profitable trades. This means
that you keep raising your stop as the price of your share goes up.
Another element of risk reduction is diversification. Portfolio risk can be reduced substantially through
diversification, especially in stocks which behave differently from each other. Never bet everything one trade.
One sin that most traders are guilty of is overtrading. Many speculators take to day-trading as they can play with a
larger block of shares since they do not have to pay for them. Their thinking is that the more the stock you own,
the bigger the profit. While this is true for profitable trades, the losses will also be larger on the losing trades. Day
traders are invariably hurt very badly whenever an unexpected development causes a much larger movement
against them than they had originally anticipated.
These rules of risk management may make the market seem a little less exciting by limiting your position size and
forcing you take an early loss on stocks you like. However, bear in mind that the most successful traders always
use these rules, and if they need such rules, so do you.

Rules

Rules of risk management
Some principles to keep your trading risk at the minimum level
The stockmarket is a place where more investors lose rather than make money. However, losses can be reduced or
even eliminated by following some simple principles of risk management. We will discuss a few of these below.
These principles apply equally to anyone who is already trading in the market, or is thinking of doing so.
The first one goes against the mindset of most traders, as they get into a trade thinking only of the profit they
would make on it. The rule is to not think of the profits you can get out of your trades, but only of the losses. It is
much better to plan your reactions to a loss before entering into the trade. Decide on what you would do if the
stock goes against you, losing 5%, or 10%, or even 20%. It is better to assume that the market is going to go against
you when entering into a trade, as you are then prepared to face the eventuality.
The second principle is to use a stop loss. Most professional traders employ stop losses between 3 and 7% of their
entry price. A stop loss restricts your loss to an acceptable amount. Placing stop losses can now be done through
the stock exchanges’ ordering system. Stop losses are a vital part of trading. Even the world’s most successful
traders expect more than half their trades to wind up with a loss. It is therefore critical to keep losses at a
minimum on the unsuccessful trades. Here’s an example of a stop loss – you buy a stock at Rs. 200 and decide to
use a 5% stop loss. This means that you wish to restrict your loss on the trade (if it goes against you) to 5% of your
entry price, i.e. Rs. 10. You would then place a stop loss below Rs. 190. This means that your stock will get sold if
the price of the stock falls under Rs. 190.
Next, don’t enter the market without a clear plan. Following a tip does not constitute a plan. The plan must
include your reason for picking a stock, your stop loss and your exit strategy. Picking an exit is not easy, but should
nevertheless be planned in advance. One simple strategy is to use a trailing stop on profitable trades. This means
that you keep raising your stop as the price of your share goes up.
Another element of risk reduction is diversification. Portfolio risk can be reduced substantially through
diversification, especially in stocks which behave differently from each other. Never bet everything one trade.
One sin that most traders are guilty of is overtrading. Many speculators take to day-trading as they can play with a
larger block of shares since they do not have to pay for them. Their thinking is that the more the stock you own,
the bigger the profit. While this is true for profitable trades, the losses will also be larger on the losing trades. Day
traders are invariably hurt very badly whenever an unexpected development causes a much larger movement
against them than they had originally anticipated.
These rules of risk management may make the market seem a little less exciting by limiting your position size and
forcing you take an early loss on stocks you like. However, bear in mind that the most successful traders always
use these rules, and if they need such rules, so do you.

Rules

Rules of risk management
Some principles to keep your trading risk at the minimum level
The stockmarket is a place where more investors lose rather than make money. However, losses can be reduced or
even eliminated by following some simple principles of risk management. We will discuss a few of these below.
These principles apply equally to anyone who is already trading in the market, or is thinking of doing so.
The first one goes against the mindset of most traders, as they get into a trade thinking only of the profit they
would make on it. The rule is to not think of the profits you can get out of your trades, but only of the losses. It is
much better to plan your reactions to a loss before entering into the trade. Decide on what you would do if the
stock goes against you, losing 5%, or 10%, or even 20%. It is better to assume that the market is going to go against
you when entering into a trade, as you are then prepared to face the eventuality.
The second principle is to use a stop loss. Most professional traders employ stop losses between 3 and 7% of their
entry price. A stop loss restricts your loss to an acceptable amount. Placing stop losses can now be done through
the stock exchanges’ ordering system. Stop losses are a vital part of trading. Even the world’s most successful
traders expect more than half their trades to wind up with a loss. It is therefore critical to keep losses at a
minimum on the unsuccessful trades. Here’s an example of a stop loss – you buy a stock at Rs. 200 and decide to
use a 5% stop loss. This means that you wish to restrict your loss on the trade (if it goes against you) to 5% of your
entry price, i.e. Rs. 10. You would then place a stop loss below Rs. 190. This means that your stock will get sold if
the price of the stock falls under Rs. 190.
Next, don’t enter the market without a clear plan. Following a tip does not constitute a plan. The plan must
include your reason for picking a stock, your stop loss and your exit strategy. Picking an exit is not easy, but should
nevertheless be planned in advance. One simple strategy is to use a trailing stop on profitable trades. This means
that you keep raising your stop as the price of your share goes up.
Another element of risk reduction is diversification. Portfolio risk can be reduced substantially through
diversification, especially in stocks which behave differently from each other. Never bet everything one trade.
One sin that most traders are guilty of is overtrading. Many speculators take to day-trading as they can play with a
larger block of shares since they do not have to pay for them. Their thinking is that the more the stock you own,
the bigger the profit. While this is true for profitable trades, the losses will also be larger on the losing trades. Day
traders are invariably hurt very badly whenever an unexpected development causes a much larger movement
against them than they had originally anticipated.
These rules of risk management may make the market seem a little less exciting by limiting your position size and
forcing you take an early loss on stocks you like. However, bear in mind that the most successful traders always
use these rules, and if they need such rules, so do you.