How to reduce risk in stock market investment |

One of the biggest myth and the
same time a truth about stock market is that it is the riskiest business in the
world and most of the people lose their money here. Well, this is a myth and a
truth at the same time. It’s a myth because most of the people don’t lose their
money. Yet, it’s partially true as it is highly risky sometime and many lose
money too.

But, if you are not skilled in
something, you are sure to fail, isn’t it? Stock market is a place for
professionals and crafty businessmen. If you have proper knowledge and your
moves are calculated well, you are bound to become a millionaire through stock
market investment. For that, you need to learn to manage the risk factors
present in the market. You have to follow some rules to reduce those risks.

Followings are some essential
equity risk management strategies.

1. Diversify your portfolio

Portfolio diversification is the oldest and most effective way of mitigating risk factors in stock market. If you are heavily investing, don’t invest in a single sector or a single entity. If you do so, you might lose all your capital when the sector goes down. So, diversify your investment, buy stocks of different industries.

Invest in several sectors; Image Source: Elearnmarkets.com

Again, diversification too need to
done in a diverse way! You can just keep investing in different products or
industries without analyzing the catalyst factors. There are certain sectors
which are influenced by the same catalysts. If you invest different sectors
which are influenced by same catalysts, your diversification will be of no use.

2. Using stop-loss

Though this method has some disadvantages too, it could be a very effective strategy to mitigate risks in stock market. Stop-loss is the system of setting lowest limit. You can set the lowest limit of your share where you’d not want to hold it and if the price falls to that point, it’ll be automatically listed for sale.

For instance, suppose you bought
some shares for Rs 100 each. You want to hold them till the price increase and
then sell. But, if the price falls, you don’t want to let it fall too much and
cause bigger loss. So, you can set your stop-loss price suppose Rs 95. If your
share’s price falls at 95, it will automatically be listed for sale.

A risk of doing stop-loss is that,
sometimes price falls are instable and falls big time with a short period. But,
once stop-loss is activated, you can’t change it and your share will be sold
with the market price. Suppose, your Rs 100 rupee share’s price suddenly fell
to 80. Though, your stop-loss price is Rs 95, you’ll have to sell it for Rs 80
then!

3. Non-cyclical sectors

Try to invest in essential product
companies and sectors which never dry up. For example, invest in pharmaceutical
sector. Medicines are such products that people can never stop using. Even
during economic depression, people need medication. They might reduce the usage
but medicine is a must. So, this sector will ensure constant flow of growth and
income. There are many such non-cyclical sectors to invest.

4. Hedging

As the name suggests, this strategy is the hedge around you to protect you from loss. You can add hedging instruments like Futures and Derivative Contacts to diminish risk factor. Futures is the set price of share which will be in effect if your share’s price falls within a time period. You will be able to sell your share at higher price than the market price overlooking the fall.

Reduce loss by portfolio hedging; Image Source: alphagamma.eu

Derivative contacts on the other
hand, is the process of buying a stock for a certain price even if its price
rises at the time of buying. Both of the processes do not pose any risk but not
promise high profit as well. This strategy is for the beginners or the small
capital investors.

5. Go for the dividend paying
companies

This is a simple strategy to reduce risk in investment. Dividend is the distribution of profit. Corporations or companies give their shareholders a part of their profit which is called dividend. Usually, the companies making good amount of profit give dividend to its shareholders. Again, if a company’s dividend pay rate graph is constantly on the rise, it means the company is sustaining its growth and making lots of profit. So, while buying share, one can study about the dividend payment status of the companies and choose the most stable one, which would essentially reduce some risks.

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