A trading market is a tricky place where you can either succeed and become rich or get swallowed by tricky price variations. Once you join the trading market, the risks will follow your moves and appear whenever you make a wrong turn.
Risk management is the process that will help you identify and control the threats and decrease the loss. As a person who is setting aside money for retirement, you should focus on the risk of losing all the money you’ve invested in stocks and options.
Here are the risks that might come across the trading market.
Introducing the Risks of Trading
Risks may appear in different shapes and at different times. Some of them can be considered, while others can not be predicted because the trading market is a mystic and tricky place.
Particularly, there are different risks, among which we can separate some that might negatively reflect your wealth. The first one is your securities losing their value, then losing all your money and confidence and giving up.
Feeling lost in these situations is okay, especially if you are not well-prepared for the consequences. However, we will try to explain some strategies to help you avoid the risks or decrease the loss to its minimum.
Risks of Trading Options
Options carry no guarantees. It is the same as trading stocks, mutual funds, and bonds. Before getting into the options trading process, you must be aware that you may lose your entire principal and sometimes more.
Buying calls and puts
When buying calls and puts, the risk is generally defined and limited. In this case, the most you can lose is the amount you have invested or the premium you have paid for those options + commissions.
The story ends here. The height of the loss equals the amount you’ve invested. If you have invested a small amount of money, the risk will be low and not drastically affect your bank account. In this case, the profit you may receive in a reverse situation will also be low.
Nonetheless, you may face a big material loss if you’ve invested high amounts without considering the possible risk.
So, for the option buyer, an obvious danger is when the underlying asset does not move in the desired direction. This situation forces the buyer to let the contract expire and lose the money they paid as a premium.
Selling calls and puts
When selling calls or puts, your maximum profit is the premium you receive for selling the option with fewer commissions. Selling calls and puts is also known as “writing.”
When selling ”naked” (uncovered) calls, the risk that appears is your stock being called away by the option buyer. In this case, you are obligated to sell the stock at its strike price if the call buyer chooses to use the right to buy it from you.
This usually happens when the call option is “in-the-money” or when the stock price exceeds the strike price and the contract time gets closer to its expiry date.
As an options writer (seller), you carry a higher risk than options buyers. If you write a “naked” (uncovered) call, you may face an unlimited loss because there is no restriction on how high the stock price may get.
Risks of Trading Stocks
Investing in stocks might lead to losing all your money and sometimes even more. Similar to trading options, you must understand the risks before risking high amounts of money. So, here are the risks of trading stocks.
No guaranteed returns
Nothing guarantees that you will make a profit on a specific stock at a specific point in time. Stocks can be unpredictable, and no one knows how a particular stock will perform in the future.
Also, you can not predict when and if the prices will go up or the company will pay out the dividends.
Possibility of losing money
Stocks may change for different reasons, like dividend announcements, employee layoffs, management change, accounting errors, new large contract secure, earnings and profit releases, etc.
So, you should accept the risk of losing all your money when trading stocks, especially if investing in long-term ones. The risk of losing more than you’ve invested might appear if you use leverage for investing in stocks (short selling or buying on margin).
How to Reduce the Risks of Trading
Diversification
A strategy that reduces the risk by distributing investments across various industries, instruments, and other categories.
It is important to own investments in different classes so that you can reduce your risk exposure if one of them fails. A diversified portfolio includes separate stocks from different industries, like ETFs, global stocks, mutual funds, bonds, etc.
Stay informed and ask for advice
Being well-informed helps you understand the market volatility variables. Interest rate decisions, economic reports, events, quarterly earnings reports, and trade wars might cause enormous market movements. Understanding these factors might help you predict the risk of a specific industry you are interested in buying stocks.
Investing might be risky if you are not completely informed about how the stock market works and what affects the stock’s price. To increase your knowledge and feel safer, you can rely on a trading service like FoolProof.
Rely on realistic goals
Set a realistic profit goal that is not too high. High goals carry higher risks, so it is best to play it safe.
Don’t buy private stocks
Some companies keep their stocks in private hands instead of sharing them publicly. Private stocks carry more risks because you may be unable to buy/sell a stock when you want to, or you might be asked to make a large investment. Also, private stocks might appear as a scam.
Conclusion
You may face a lot of risks in the trading market. The worst scenario is losing all your money, while the best one is making a profit you can not make by working 9 to 5.
Risk management is the key to successful trading. Use the best trading strategies to manage the risks and minimize losses.