Trading Risk ManagementTrading risk management. Risk management and stock trading. Stock trading risk disclosure. Using stop loss and limit orders to lessen internet trading risk. Stock market diversification and position sizing.
The net result is that you will make a lot more money from market trading. Before you can manage the risks you will be taking on by trading stock online, you must understand what those risks are.
Stock Trading Risk DisclosureThis is buried in the prospectus of every publicly traded company. It basically outlines all the various risks that apply to that type of business.The most common offender is credit risk. If a company cannot arrange financing for its future endeavors, it may go bankrupt. The way you assess this risk, outside of reading the prospectus, is you look at their most recently filed financial statements. These are available for free online and are a valuable source of information. Check to see if they have enough cash to keep them afloat for the duration of time you plan to be invested. Bankruptcy is the single biggest stock trading risk. If a company goes belly up while you are holding its stock, you lose everything you've invested. Stop loss orders can be used to protect your capital under all other circumstances but only your own due diligence will protect you from bankruptcy risk. Don't trade companies that are not financially sound. Another type of risk you may discover in a risk disclosure statement is the risk of the company losing an important contract. This is a greater risk for small cap companies than for large caps. You may have to read the companies quarterly report or listen to a conference call to find out how many contracts they have and the value of each one. The greater the percentage of revenue a company derives from one contract, the riskier an investment it is. Some biotech companies are dependent on a single supplier for a component without which they cannot operate. If that supplier fails them, they won't be able to fill their orders. Be wary of such situations.
Stock Market DiversificationStock trading diversification is an important part of any trading risk management strategy. It's the old "Don't put all your eggs in one basket" adage.No matter how small your trading account is, break it up into several pieces. You will have to trade for a while before you will know how many positions you can comfortably run at once. Three is a good number to begin with. Make sure the 3 stocks you pick are in different market sectors. Don't buy DG (Dollar General) and ARO (Aeropostale) because although they are very different businesses, they are both retailers. Likewise, you wouldn't want to trade C (Citigroup) and GE (General Electric) at the same time as GE trades with the financials. As far as position sizing is concerned, the simplest thing to do is divide your capital into the number of stocks you will be trading. If you are just learning about the stock market, trade small positions (less than $5,000) until you are consistently winning in the stock market. The psychology and logistics of trading large blocks are different.
Stock Market OrdersTry to buy and sell your positions using limit orders whenever possible. Over time, this can save you a bundle.Limit orders are not appropriate for every trade, but the risk with a market order is that the market maker will fill your order at a much different price than you expected. Once you've opened a position, put a stop loss order in on it immediately. This forces you to decide ahead of time how much you are willing to lose if the trade goes against you. Don't make the mistake of keeping the stop in your head. Place the order! If you don't, once the price falls, you will likely freeze and refuse to sell. By the time you snap out of it, you may have taken a much bigger loss than you would have if you had run a stop on the position.
Equity volatility risk has to do with the level of threat to your stock market holdings because of equity market volatility. You will want to consult volatility indicators like the VIX volatility index (symbol VIX) frequently as part of your trading risk management strategy. Levels between 10 and 20 are best for low volatility investing.
Internet Trading RisksYour computer can crash.Your online broker's system may go down at an inopportune time. You may think that you can just call and place your order by phone but the lines may be jammed by other traders trying to do the same thing. Your internet service provider may decide to do some maintenance just as you are trying to enter an order. These are the risks of online trading. The only risk free trading is paper trading stock. The risks are real. But good trading risk management will soon have you on the road to profitable stock trading.
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