A good investor constantly seeks to reduce his risk, because he knows he cannot predict the future. Indeed, if it were possible to anticipate market volatility and eliminate risk, everyone would be rich!
It is this volatility, the constant fluctuation of prices up and down, that defines the stock market. Knowing that it is impossible to completely eliminate risks, it is in your interest to reduce them as much as possible, which also helps you to maximize your gains.
To achieve this, a risk management strategy should be followed.
1. Diversify your portfolio
Diversification involves reducing volatility and risk in a portfolio by investing in different asset classes. i Thus, all the eggs are not in the same basket: you limit your overexposure to one or other of these categories, and your overall risk profile is reduced. A diversified portfolio can include stocks from different sectors, bonds, mutual funds, ETFs, global stocks, etc.
Why is it important to diversify your portfolio? Because it’s very risky to put everything in one place. Indeed, if the price of certain stocks goes up, others depreciate. The return of a diversified portfolio is usually lower than that of an investor who has the lucky hand by betting on a single promising stock. ii However, if the price of this stock begins to fall, this investor could suffer significant losses. This is why diversification is the golden rule of investing.
2. Follow the 2% rule
An investor who follows the 2% rule never risks more than 2% of his available capital in a single stock trade. iv This strategy allows you to reduce losses in the event that the market goes in the opposite direction. This 2% is considered an acceptable level of risk.
This strategy fits well with one of the tenets of stock market trading: never risk more than you are prepared to lose. Many beginners ignore this rule, under the illusion that they will never suffer losses.
3. Stay informed
To be successful, one must understand the factors responsible for market volatility. It could be interest rate decisions, trade wars, economic reports, company reports on their quarterly results, or any other economic event big enough to move the market.
Understanding the broad outlines of these factors and staying up to date with the latest news will help you reduce your risk. In addition, there are many market studies on which you can rely to establish your own investment strategy with confidence. v
4. Stay consistent and avoid overconfidence
Some investors, especially beginners, become victims of their own successes: they realize gains after a few trades and believe that the next ones will be just as profitable. Overflowing with confidence, they increase the capital invested. Losses are likely to hurt a lot if the market suddenly changes direction.
5. Set realistic goals
Another way to reduce risk is to set realistic return goals on your initial investments. The higher you aim, the more risks you have to take to achieve your goals. When an investor performs below their targets, they are more likely to act recklessly to close that gap, exposing them to heavy losses.
6. Let emotions guide you
Don’t let your feelings and emotions, such as panic, impatience, fear or strong reactions, dictate your trading activity. The same goes for attachment to a particular company. Basically, you have no control over the price of the market, but you do have control over your reactions to it.
Wanting to buy low or sell high
Predictions on the floor or ceiling price of a stock are never without risk. vi Truth be told, in the stock market, no prediction is a guarantee. The thing is, no one really knows which direction the market will take.
Investing without proper planning
Your strategy shouldn’t stop at “making a lot of money in the stock market”. A seasoned investor follows a specific buying and selling strategy. He determines how much to invest and how much he is willing to lose. He stays on the lookout for possibilities without deviating from his plan.
Learning to reduce your risk is absolutely essential if you want long-term success in the stock market. Yes, you need to keep an eye on the performance of your investments. But above all, you must monitor your ability to recover the capital invested without incurring losses.