Risk Management Strategies – How To Manage Risk In Stock Market ?

Most of the beginners or the ones planning to invest in stocks, their mind might cross the rumors “Stocks are risky, this may spoil your life too”. Some of us even think it is a kind of addictive gambling. Agreeing with the fact that it is “risky” but not to the fact it is risky enough to spoil your life. With the risk factor comes measures to cut the risk or manage it. There are various ways to mitigate risk in the stock market investment

What Are The Measures For Equity Management Risks?

There are several management measures but let us discuss a few of the major keys:

  • Portfolio Diversification. 
  • Using stop-losses.
  • Adding Non-Cyclicals in the portfolio.
  • Hedging.
  • Investing in dividend-paying stocks.
  • Pairs Trading 

Portfolio Diversification

Bussiness always remains susceptible to the rise and fall, this makes committing to a particular stock risky. This risk may infer bad marking to your portfolio. So, it is advised to trade in as many stocks as you are capable of. This practice may give chance to mitigate risk generated by one stock investment to subtle by the performing stock. While doing so, make sure you invest in different stock which does not have anything common with each other. This is a great move, as you invest in different stocks the risk of one stock not performing won’t affect the other stock because the risk factor is different here. 

For example, investing in TATA Motors and Tesla is similar, they both have the same risk factors and risk mitigation is not much helpful. 

Always keep in mind, diversification does not mean equally investing in all sectors. This means investing in one or more assets or sectors with different USPs.  

If you like anything about a particular company, you may invest more but also keep in mind if they go to losses you might suffer as well. 

Using Stop-Losses

A stop-losses order has a right to sell the stock when it is found to get in loss, the broker initiates the process. During sharp market corrections, this order protects you from further losses. This checks your tendency to sit on a loss-making company for too long in a hope that it re-build itself. 

For example, if you bought a stock of price Rs. 1000 and the stop-loss on it are Rs. 900. The broker will then and there sell the stock when it reaches  Rs. 900. When the stock falls behind, the risk is now mitigated. 

Adding Non-cyclical To The Portfolio

The companies that come under this sell essential goods, such as goods that do not get back to the economy. Such companies are Pharmaceuticals and FMCG. The main reason is that people will never stop buying this as it comes under essentials and daily needs criteria. Healthcare, groceries, and such things come under day-to-day needing and necessary products. So, the non-cyclical have stable revenue, thus making the stock stable in pricing. Many experts may find it “Defensive”. 

Hedging

Using derivative instruments like future and options contracts for the risk management strategy is called hedging. This future contract helps to fix the price of the future buying and selling transaction of the stocks. This way one can Lower the chances of price or stock fluctuation. Even if the price of the stock falls, you with the futures contract can sell with a higher price fixed. Thanks to the derivative contracts, you can buy lower rates even if the price rises. There are different contracts one can use accordingly. 

Investing In Dividend-paying Stocks

A history of consistent dividend distribution becomes the stronger and more established company. Adding such companies to your portfolio makes the shield against equity risks.  

A dividend cut is usually an indication of poor financial health, so companies focus not to cut their dividends for this reason. This way the dividend- stocks ensure to give a constant pay or return even if the market is down. More predictability and stability are promised in this method.

Opting for Blue-Chips Stocks

Small or medium-sized companies are more likely to suffer risk, they have vitality in the market. Meanwhile, the emerged business is more stable and does not suffer in the stock market as such. So this can be said, the stock market is not risky for all. Risk mitigation can be done by following this simple rule. 

Pairs Trading 

Pairs Trading is a strategy that involves matching two stocks one of which is long position stock and the other is small position, that has a high correlation. When the pairs trade is performing well, the investors get the profit as well. The profit here generated by the security becomes underperforming and the outperforming security’s price deflates. This way the net profit is evaluated. 

Bottomline 

It is well known that the stock market is volatile and unexpected and the risk is expected. Though, there are several risk mitigation tools in equity markets that you can use. These help you enjoy the high returns that investing offers and neglect the high-risk factor. 

Some Frequently Asked Questions (FAQs)

  1. Can You Over-diversify A Portfolio?

    Over diversification is one of the options as some mutual funds have to own so many stocks. This then becomes hard to outperform at any cost. 

  2. Can a blue-chip stock’s failure be possible?

    The blue-chip stocks mostly are not in the verse of failure. Most investors buy such types of stocks and hold them for long-term purposes. 

  3. Do blue-chips pay dividends?

    Yes, blue-chips have a strong history of performance and often pay dividends. 

  4. How does risk affect the stock market?

    The downfall of one sector might spread bad performance to the entire market, this affects the stock market adversely. Diversifying the stock will help solve this problem. 

Shivangi Singh

Shivangi Singh

I am currently pursuing my Bachelor's in Aerospace Engineering in my final year at the University of Petroleum and Energy Studies. I like to read books and learn new things that help me in my overall growth. I am a people person and love to know and interact with new people. I also like to visit new places and learn about its culture, food and history.

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