It is a world of speculations so it is a smart idea to deploy some risk management techniques. These are a few simple techniques we have got for you.
Find out your risk tolerance. Ask yourself some hard and realistic questions. For example, if your portfolio was to drop a sudden 10% today, what are you going to do? Sell all holdings and get out? Or are you going to wait to see the price momentum? Or are you going to pick up more? This hypothetical scenario can very likely happen because the market has witnessed multiple crashes throughout history. So it is valuable to sit down to think these questions through. It is crucial to give honest answers so your financial advisor can suggest appropriate funds or investment plans or stocks.
Consider your risk capacity. Risk capacity is about how much risk you can afford to take given your situation, not how much appetite you have for risks. You might be a risk-taker but if your liquidity is not that great, you should not take on too many risky securities in your portfolio. Your risk capacity is also small if you are retiring next year or sending your child to college in the very near future. Your risk capacity will likely change throughout your lifetime.
Readjust your asset allocation regularly. Your goal is to buy low and sell high. It sounds intuitive but not many people achieve this goal because often we like to follow the buying momentum (sometimes it pays off when you don’t overstay) and panic sells. As you start your investment portfolio, decide on what percentage of your investment goes into individual stock holding. Then have a rule for when you have to readjust your holdings by selling some of the leaders and buying some more of the laggards. It is recommended that you stick with the rule despite how the market is doing. If not, you might be taking on more risks than you have anticipated.
Use the sell stop-loss function. When you make a trade, meaning buy or sell, you can do it at 4 different prices: market, limit, stop, and stop limit. In our case of protecting our asset, we would use the sell stop-loss function because this method would trigger a sell order when the asset price falls below a set market price. This will limit the loss to your predetermined level.
Write covered calls on your holdings. Covered calls are an options strategy that you can use to earn some income on an asset and thus it reduces your potential loss. Because you are holding a long position on an asset, you can sell call options on that same asset. Writing call options will require a great understanding of how options are priced. But this strategy is feasible only if you are holding more than 100 shares of an asset.
In conclusion, your personality, which is unlikely to change throughout your lifetime, greatly influences your risk tolerance. Your age and liquidity affect your risk capacity. Knowing your risk tolerance and capacity can help you build the right portfolio that can withstand market downturns and unforeseen personal situations. You should stick with your “asset adjustment” rule to avoid overloading risks. You may also consider the sell stop-loss function to limit potential loss to your predetermined level. You should consider writing covered calls on your long position asset to make some income.
