Stock markets are associated with a lot of financial risk to the participants.Being a riskier asset doesn’t make it disqualify as an investment option.In fact, Equities are the only asset class which can generate best returns on your capital and beat the impact of Inflation in the long run .Now if you are a trader or investor in the markets,it is very important that you manage your risk properly otherwise you may be left watching markets eroding your hard earned money.Small risk management with some basic knowledge can protect your capital from unfavourable market conditions.
Types of Risks –
As a market participant,you are exposed to two types of risk as far as your money is concerned.They are :-
1) Market Related Risk
2) Company Related Risk
Market Related Risk – These kind of risks are common in situations of deteriorating fundamentals of economy like recession or economic slowdown or credit rating downgrade etc which can lead to long bear markets.In such scenarios,Investors are prone to loose some or major part of their capital.To avoid yourself falling into such a situation,you should manage your risk by choosing blue-chip stocks which have strong fundamentals.The investment in these stocks should be scattered over a period of time and avoid lump sum investing with all your capital.Scattering your investment over a period averages your buying price thus lowering your risk potential while maximizing returns when the market trend changes to positive side.
Company Related risk – Company related risks are associated with any specific company you may be invested in.If you have put all your capital in a company and that company defaults,you run the risk of loosing your money.Company related issue can be anything like a bankruptcy,fraud or any major corporate issue.These risks can be minimized by Portfolio Diversification.
If you have a certain sum to put in the markets,and you are thinking of buying a single stock with all that money then you taking dual risks of Market and Company related.To reduce the Company risk,you can buy 2 or 3 stocks from that sector in which you were to buy single company stock.By doing so,even if one company defaults,the other stocks from that sector may lessen your potential loss or can make up the loss totally if they perform well.
Another issue arises sometimes when a whole sector in the markets doesn’t perform well.Suppose you are holding all the stocks from a particular sector like Oil & Gas or Telecom or Information Technology.Markets are on the boom with other sectors like Banks,Realty or Metals etc are outperforming.You will definitely feel being left out of market in spite of being in.You should diversify your portfolio to avoid such a situation.Portfolio Diversification with exposure to all or major sectors in the markets hedges your portfolio against unwanted market movements and increases your profit potential.It is also important that you don’t buy too many different stocks with all your capital but keep it to such a number that you can track them all and your portfolio is also well diversified.All in all we can sum up it in one line –
“ Don’t Put All Your Eggs in One Basket “