Risk is the other name for Stock Markets.The moment you enter the markets,the risk of losses to your capital starts and you should always look to limit losses.The associated risk doesn’t make trading or investing in markets unpopular.
The fact is that the Equities or Stock Markets are considered the best asset class among the investors.It is the equities which are capable of delivering best returns to the investors in the long run while beating the Inflation rates.Same is true for short term trading where you can get very decent profits on your trades in a short time.The need is to limit losses on your trades.
Always keep in mind that all these profits come while taking a substantial risk.If you can contain your risk,trading can be a fortune turner for you.
While you can never reduce risk to Zero,you can always reduce this risk of loss significantly by following some simple market rules.Cutting the losses is as important as earning the profits.Using Support and Resistance
Support and Resistance make an important and essential part of your trading plan.Before going for a trade,you should be prepared with the support and resistance price levels for the stock or security you are going to trade in.
Support is the price level below which a stock is less likely to fall while a resistance is a price level above which the stock is less likely to move.While a stock can always move above or below these levels,they provide you the range in which you have to play the stock.
If you want go long or buy the stock,you should be buying it as near as possible to the support level but not if this level is breached.Similarly,if you want to short or sell the stock,do it as near as possible to the resistance level.These levels act as your stop losses and in case the stock breaches these price levels,the loss incurred to you is relatively smaller.
Using Stop Loss
You should make it your habit to use Stop Loss in your trade.Sometimes we think that we will keep stop loss in our mind and actually don’t apply it in fear of getting it triggered.This is because we don’t want to exit our trading position taking it to our ego that we can not go wrong.
It is always in your favour to apply stop loss in your trade and get out of the trade gracefully if it gets triggered.Remember,market is always right.Secondly,never re-enter that trade even if stock again moves above your stop loss after breaching it.
You can also use stop loss to enter a trade like we talked above for exiting the trade.This is done when you have the urgency to enter a trade but the stock is trading away from the support or resistance level.Suppose a stock is trading at ₹ 500 and support is at 480.You want to enter near 480 but are afraid that stock may not test 480 and may move higher but you also want to wait for 480.You can keep stop loss buy order little higher above 500 and wait for correction in stock.If stock corrects,you can trail stop loss lower and if stock doesn’t correct but moves higher,your stop loss will get triggered and you enter the trade.
The disadvantage with this is that method is that you end up entering the trade at little higher price.Similarly,you can use stop loss sell orders for shorting the stocks.
Analysing Risk to Reward Ratio
After you find your support and resistance level for the trade,next you should analyse the Risk to Reward Ratio.Are you going to get enough return on the trade for the risk taken?
You should look to trade the trades only with risk to reward ratio equal to greater than 1:3.While most of the trades don’t fit into risk to reward ratio parameter,you will be thus avoiding unnecessary trades.This saves you of undue brokerages and losses on these trades.
Preferring Limit Orders
While placing orders for the trade,it is important that you prefer Limit Orders to Market Orders as far as possible.A Limit Order is an order which you want to be executed at predetermined price by you.
If the stock price comes at Limit Order,this order gets executed.A Market Order is one which you want you want to be executed at any best price available in the market at the time of placing the order.
While the advantage with Limit Order is that you are entering the trade at your chosen price,the disadvantage is that it may not get executed if the stock price doesn’t visit that price.The Market Order insures your entry into the trade,this price may be different than the price you wanted to enter in.
This is not a technical point to limit losses.But it has its own importance.You may have seen by yourself that whenever you enter a trade,the stock starts moving in your undesired direction.You are left regretting that had i waited little more i would have bought it lower.
Patience coincides with our first rule of waiting till support and resistance.Stocks have highly likelihood of testing these level.All it requires is little Patience from you.Patience ensures you enter the trade at a better price.
Following these simple rules ensures that your trading losses are cut significantly.If you have any more in your mind or you learnt with your experience in markets,share with us!