How to Reduce the Risk of Trading Risk of Shares?

What are Shares?

Share trading remains one of the most popular asset classes among retail investors and traders. Shares are also known as stocks or equities, they represent partial ownership of a company. Often, dividends may be paid out on a half-year basis to shareholders based on the proportion of the company they own.

Moreover, there have been financial derivatives products created, which derive prices from the movement of the underlying stock price.

Share CFDs are an example of share derivative products, with effective low trading costs. Unlike common stocks, CFDs do not grant shareholders the right to vote in a company, it still allows the holder to receive dividend payments on the ex-dividend date.

The Risks Associated with Share Trading

Trading risk is referred to the risk of potential capital losses incurred when failing to deliver the expected return.

Managing risk effectively is an integral part of trading, regardless of the financial products traded – shares (share market), foreign exchange (Forex), bonds, or commodities.

The most recent debacle on Bill Hwang losing 20billion in 2 days is a key lesson on the importance of risk management, as losses are inevitable regardless of how great your strategies are. 

Trading Plan

When it comes to risk management, it’s important to have a trading plan that you’ll actually follow. A trading plan is a road map, a framework designed to keep your trading process in check. It is the first step to mitigate trading risk.

Examples of trading plans include using money-management systems, risk-management strategies, market selection, and a trading journal.

Have a plan helps the trader to have discipline and maintain an objective mindset.  

Plan the Trade with a Protective Stop-Loss Order

A protective stop-loss order is a risk management approach to effectively cut losses and preserve a trader’s equity. This method minimizes excessive losses bared by the trader due to excessive market volatility. 

According to Metatrader 4 statistics, many traders fail to set a stop-loss level. This could be due to traders adopting mental stops instead. However, a soft stop could be dangerous if the trader does not have sufficient emotional discipline to exit the market at their mentally set level. Furthermore, during rapid and drastic price movement, a hard stop-loss may experience slippage, but the account fluctuation may be drastically worst with a soft stop loss.

Risk Per Trade

As a trader, it’s best to know your own risk tolerance level. On a single trade, 2 percent of account equity is a general rule of thumb. However, this may depend on the type of trader you are. Short-term traders tend to take more positions and therefore ending up at risk of 6% to 10% of their portfolio. Whereas, a long-term trader may be comfortable with 3 percent per trade as the trader may take less than 10 traders each year.

Additional Risk-Management Factors

  • Position size determine the number of contracts you should hold relative to your account equity
  • Leverage and margin: higher leverage increases your risk and rewards exposure with lower margin requirements and vice versa.
  • Risk-to-reward: how much you are willing to lose vs. your expected gains. Most traders target a 1.5 times risk to reward on a trade.

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