Trading the capital markets requires strategies that provide information about the amount of money that you plan to make, and how much you are willing to lose. The loss calculation is something that generally gets lost on novice investors. Few think about how much they are willing to lose when they embark on a trading strategy. Additionally, when you start to trade, you want to separate your risk management into long term and short-term risks. This way you can design trading strategies that can work for each type of trading method.
Using Diversification
One of the best ways to handle your long-term risk management is to diversify your portfolio. Asset allocation and diversification are methods that force you to put your money in different assets. For example, if you put money in stocks, bonds, currencies, commodities and cash, you are unlikely to experience an adverse market move with each product all at the same time. When riskier assets tumble, stocks and commodities might decline, but bonds and gold might rally. In addition, you might consider diversification within a specific area. For example, if you are a stock investor, you might want to use exchange traded funds (ETFs), that focus on specific sectors. So, if riskier assets are declining, some that are defensive like Utilities and Consumer Staples might rise in value.
Risk Management on Trades
Each trade the you place should also have specific risk management before you execute the trade. This means that you want to have a level where you will stop loss out of your trade and a level where you plan to take profit. One of the most important rules is that you want to cut your losses and let your profit run.
One way to do this is to use a trailing stop loss. This is a stop loss that moves up in value as the trade moves your way. For example, if your goal was to make 5% and you are willing to lose 2%, when the trade moves 3% in your favor you can move your stop loss level up, to make sure you don’t lose money on your trade. As the trade continues to move your way, you increase your stop loss level.
Do Your Homework
With any investment you’ll want to be sure you know whats going on with the companies you’re trading. This involves knowing the market, the companies cash flow, the track record of the management, etc. A good way to get a hard and fast assessment of the company is to check and see if insiders are buying or selling the company’s shares. There are several niche sites that let you do that, but a good place to start is insidertrades.com. If they don’t have what you need, try yahoo finance.
Summary
Risk management is one of the most important features of trading the capital markets. If you stick to your plan, you will limit your losses and not be afraid to trade. For long term trading, you should consider diversifying your portfolio. If you are trading short-term, you want to make sure you have a stop loss, a trailing stop loss and take profit levels in place before you begin to risk your capital. The advantage of using these techniques it allows you to live another day.
