Risk Management In The Stock Market

By Jon Lynch

You should be aware of the main risks associated with investing in listed equity securities.

Some of these risks are:

Overall market risk: This is the risk of loss by reasons of movements in a market sector. These can be caused by any number of factors including political, economic, taxation or legislative. Specific examples include changes in interest rates, political changes, changes in superannuation laws, internal crises or natural disasters. Market risk can be minimised by having a spread of investments across different types of assets.

Global risk: This is the vulnerability of an investment to international events or market factors. This would include movements in exchange rates, changes in trade or tariff policies and changes in international or bond markets.

Sector risk: The risks associated with an industry’s specific products or services such as, demand for the product or service; commodity prices; the economic and industry cycles; changes in consumption patterns; lifestyle and technology changes. This may be minimised by detailed research to identify quality investments, reviewing their performance and their place in a portfolio.

Equity specific asset risk: Risks associated with the specific investment, for example, quality of the company’s directors; the strength of management and key personnel; profitability and asset base; debt level and fixed-cost structure; litigation; competition levels; liquidity of the investment.

Timing Risk: The possibility that you enter the market at a bad time – for example, just before a fall in the share market. This can be minimised by not investing all of your funds into the market at one time.

Speculative Risk: If an investment is described as speculative you should be aware that the investment could rise significantly but also fall by the same degree. You should not invest in speculative investments unless you understand and accept the risks fully and are prepared to accept any resultant loss.

Trading in the stock market may involve more risk. Trading is the same as operating a small business. To survive, you must manage all aspects of your business in a manner that ensures your long term sustainability. Risk management is the most important aspect of trading and is often neglected by many traders. This may account for the high failure rate of traders.

Risk management involves setting rules and guidelines that keep your risk at a level that you are comfortable with. Risk in a trading sense refers to the possibility of losing money in the market place (market exposure). The main variables that affect this liability are listed below:

* Trade position size

* Stop loss size

* Market tracking abilities

* Volatility of shares

If we are able to control these variables then we can control risk. This should always be one of your principal considerations when developing any trading system.