Risk Management Part 2: How To Deal With And Control Risk?

As long as you are in the share market, risk looms. When you hold a stock, there is an invariable possibility of a price drop. The objective of stock trading is to make consistent money by carrying out trades with more reward than risk. 

Most investors tend to focus too much on the rewards side and not enough on the risk side.

If you regulate a portfolio with sentiments and not discipline, then be prepared for an explosive and depleting ride. 

With thoughtful and regular work, you can acquire successful trading habits. Cultivating habits for producing positive results is always worth it. However, it requires immense discipline.  

Your goal should be risk management not risk avoidance. Risk can be managed by significantly controlling the possibility and the amount of loss.

Before each trading day, you must mentally rehearse about handling each position based on what can unravel during that day. Thereafter, when the market opens you will know how to respond and there will be no surprises.

Contingency planning plays an important role because it helps you to make good decisions when you need them the most. You cannot control the magnitude of a stock price, however, you can monitor the amount you lose on each trade. 

Always define your risk in advance. Not defining a predetermined level of risk may prove to be more fatal and costly than any other mistake. 

Praying and hoping for a loss recovery cannot be a part of your psychology if you want to achieve super performance. Sticking to rules and discipline and maintaining a positive reward/risk ratio will result in money inflow.

If you get stopped out of your positions repeatedly, there can only be two wrong things:

1. The stock selection criteria are faulty.

2. The general market environment is adverse.

If you encounter an unusual losing streak, cut down your exposure first.

In a tough market environment, profits will be smaller than usual and losses will be larger. You will experience greater slippage because downside gaps will be more common. A wise way to handle this is to do the following:

• Tighten up stop losses. If you cut losses at 7-8%, start cutting them 5-6%.
• Settle for smaller profits. If you usually take profits of 15-20% on average, keep it at 10-12%.
• Reduce your exposure in terms of position size as well as overall capital commitment.

If you rely on diversification for protection, you will not achieve super performance. When you spread your money all over the place, you attain three things:

1.Inefficiency to follow each company closely.

2.Failure to reduce your portfolio exposure rapidly when required.

3.Average results because of the smoothing effect. 

Conclusion

Smart people learn from their faults but really smart people learn from other people’s faults. The author has followed this ideology by carefully studying the great traders and imaginative thinkers. He has made his part of mistakes and has learnt tough lessons. In this book he presents a realistic plan which is based on his experience. It’s now up to the traders to enforce it and stick to the discipline. Doing this will surely be worth it.