Trading Risk: What You Need To Know
Trading goes hand in hand with risks. In short, trading could mean risking part of, or all the money you put into an investment. There’s no guarantee that you can always earn profits when trading, so you must know what to expect and how to face these risks.
Let’s start by understanding the risks involved in trading and how to manage them.
Investment Risks
Investment risks are connected to how you invest and manage your entry and exit points. There are two types of risks you must be aware of regarding investment risks.
Risks Associated with Opportunities
After you buy one stock, your money will be tied up to that position. However, other stock choices might interest you right after you lock up your position for another stock. Opportunity risk means there’ll be times when you’ll have to miss out on opportunities you want to invest in because you’ve already invested elsewhere. It is good to use a momentum indicator to help you choose the best opportunity to invest in.
The Risk of Concentrating Your Investments in One Place
If you often read about investing or trading tips, you must’ve read how you shouldn’t put too many eggs in one basket. Even if you trust one stock with a significant return potential, you shouldn’t go all out to invest in it. Always remember that every market has a risk. Although the prospect seems promising, you should always consider the chance of failing. The more you invest in one stock, the bigger the potential to lose. However, if you separate your investment into multiple stocks, you’ll have a bigger chance of recovering when you experience a loss.
Market Risks
When you get into trading, you must know that markets are bound to rise and fall. Understanding the risks connected to market changes can help you manage your investment better. Some market risks are unavoidable, but there are some you can manage as a trader.
Inflation
Trading plays with your mind, and if you’re afraid to face risks, inflation will impact you as a trader. With inflation, you must understand that your investment won’t be able to catch up with the costs that inflation brings. You might’ve noticed how the prices of daily necessities are increasing rapidly each year. If the financial instruments you’re investing in can’t keep up with the growth of inflation, you’ll lose your money.
Currency Conversion
When you choose to invest in stocks of companies in foreign countries, you must be aware of the fluctuations between the values of your local currency and the currency of the foreign company. When the foreign company’s stock rises, there’s a chance you’ll still lose money due to the currency exchange rates. If the value of your local currency is below the foreign company’s, your investment won’t return a profit when you convert it.
Marketability
Marketability risk depends on the liquidity of your investment. Your target selling point won’t be profitable enough if your investment doesn’t allow you to sell anytime you want. If you’re trading stocks, marketability risk won’t be an issue. However, if you’re investing in smaller companies whose stocks aren’t on major stock markets, there’s a risk of being unable to close your stock position at the right time.
Trading Risks
There are risks that are unique to trading. If you’re a position trader, you’ll rarely feel the impact of trading risks, but it’s better to be well-informed about them.
Slippage
Every trading transaction includes a small fee you might not know. Upon your entry and exit, you’ll notice a change in your balance by a small number. When you trade, you buy at the lowest price for the stock you choose, but you’ll sell it at the bidding price. The bidding price is the highest price your buyer is willing to pay for your shares. The truth is bidding prices will always be lower than the asking prices. You can manage this problem by limiting orders. In return, you won’t fill your order quota. Depending on your trading volume, these costs will slowly feel more significant.
Execution Problems
Execution problems tie to your trading broker. If your broker has difficulty filling your order, the market conditions can quickly change. The availability of the stock can change along with it, together with the availability of buyers or sellers. This problem results in you receiving a price different from what you expected. Again, you can limit orders to manage this problem, but you’ll have to risk trading through your limit price and not getting orders.
Risk Management
If you experience any of the risks above, you shouldn’t let your emotions get to you. Emotions cloud your judgment and may plunge you into a deeper hole after one loss.
You only need to see if you can minimize your potential loss without sacrificing your chances to gain from your trades. Analyze your risk and reward ratio to see the most beneficial risk to take based on the return you’ll get from it. You can also check hedging strategies and use offsetting positions to cut your losses.
