Risk management – what is it? What does it imply? Risk is basically the probability that something unpleasant will occur when it comes to investment. It is the consciousness that you may lose your invested cash. It is simple to connect risk with finances, and all sane investors would want to remove losses from the investment equation. Unfortunately, that isn’t how the market operates. Losses are a part of the investment game, and all investors can do is try to avoid it as much as possible. If you’re new to the finance world, here’s what you need to know.
Asset allocation and hedging are two prime strategies investors practice to manage risk. Asset allocation comprises shifting a portion of your investment to a more conservative one, such as bonds, and distancing them from riskier options like shares if you feel that the market may be in for a drop in the next few years. Normally, if you feel the market is heading uphill and economic conditions are becoming more favorable, you should shift a more sizable portion of your portfolio into shares and eliminate any kind of hedge you originally had in place.
Some investors manage their investment risk with purchasing options. Perhaps the simplest means of doing so is by buying “put options” to safeguard the position of some shares in your investment. Put options improve in value when the value of the share drops. They also function very much like insurance policies in that you pay an upfront charge in case a share you own drops in value. For example, you purchased a share at $50 each and it has now increased to $60. You think there will be a slight drop, yet you wish to continue holding that spot in your investment and do not want to sell it. You can then purchase a put option at $55 each for security.
A good risk management alternative is the so-called “covered call” tactic. If you own a share, you’d sell a cover call atop the present value of the share and instantly gather the cash from the option’s sale. You get the cash, regardless of what the share does, so it can add a silver lining to a flat or downhill share. In the event that the share’s price rise sharply atop the strike price, you’d be forced to sell your shares at a costlier value. Apparently, if your share drops very drastically, the few hundreds of dollars you received for the call would not completely encompass the thousands you may have lost in a substantial stock drop.
Stop loss or trailing strategies are yet another tool to ensure that you do not lose cash in the event that the stock diminishes in value. Furthermore, a universal strategy that everyone from novices to veterans must employ on a daily basis is to always exercise discipline, because it’s crucial to time the precise moment he/she should sell or purchase stock.