Among the many things the coronavirus pandemic has disrupted is the stock market. While traders will try to take advantage of the volatility to make profits, it can be hazardous unless they take steps to mitigate the risk to the extent possible. In a situation where the COVID-19 pandemic has put stock markets in turmoil, traders have to be familiar with risk management techniques, in addition to sound knowledge of stocks and other investments. Some practical tips to reduce trading risks:
Scrutinize the Risks and Rewards
You can be sure when investments offer a higher return, they are riskier. It is, therefore, better for investors looking to balance the reward and risk of an investment in keeping with their risk profile and financial objectives, says Peter DeCaprio. Investors who are averse to risk are likely to benefit by taking calculated risks to avoid the chances of missing out on a potentially lucrative investment opportunity. Of course, wealth investors may not mind losing some money if they have a greater appetite for risk. Generally speaking, investment gurus recommend a 1:2 risk-reward ratio. It means that investors need to be mentally prepared to lose two dollars while attempting to gain one dollar.
Implement Stop-Loss Orders
A stop-loss order is handy for investors seeking to minimize their trading losses. You can place a stop-loss order, which will automatically kick in when the stock’s price reaches the specified level. Every investor can set the price at which he would like to close his position for all his investments. A stop-loss order prevents investors from holding on to their investments for too long while the prices continue to fall and rack up more losses that they may not be able to bear. It is especially useful to new investors who may not know how to react when the price of a stock plunges, observes Peter DeCaprio.
Diversify to Protect Your Returns
It can be tempting to latch on to a hot tip or a stock that is rising rapidly in the hope of making a killing. However, the stock markets are notoriously fickle, and it takes very little to reverse the trend. In such a case, if an investor has put all his money into a particular stock in the hope it will rise, he will find himself in trouble if it falls. However, by investing in a basket of stocks across different sectors and industries, you can protect yourself better from the risk of loss. Diversifying your portfolio also prevents you from developing an emotional attachment to a particular stock or asset class that can potentially wipe you out if the market crashes.
Along with the above risk mitigation strategies, you can also hedge your positions by taking an opposite position in a related asset class. There are several innovative hedging tactics you can use to protect your returns. Methods like options, forward contracts, covered calls, etc., are popular for hedging. With the increase in market volatility due to the pandemic, investors will need to be more alert in following the market and actively minimize their risks.