LEARN RISK MANAGEMENT IN TRADING
One of the most important aspects of protecting your
investments is balancing your risks with reassurances.
There are several ways to do this, FIRST ONE IS
Limit Orders And Balancing Risks
A limit order is a standing amount at which you have agreed
to buy or sell a particular security or other commodity. For
instance, you have designated to your stockbroker that you
will not sell X Security until its value reaches a minimum
value of Y dollars. At the same time, you will not purchase
the same X Security if it exceeds a value of Z. Setting limits
for the price you pay for a particular security, as well as the
price you will accept to sell it, protects you and your
investment in several ways.
First of all, you are maximizing your gains, but mostly, you
are avoiding loss. Any loss that occurs with limit orders will
always be unrealized loss, or a loss that is not measurable in
liquid assets or cash. In other words, until you sell the stock
and reap the net loss, it will not affect your net worth. Since
you have set a limit that does not allow your commodities to
be sold for less than the original cost, you cannot possibly
have a loss in your net worth. At the same time, you are also assuring at least a certain amount of profit by setting
your sell point high enough to reap that particular profit.
Another way to protect your assets is to hedge. This means
that you create and sell a futures contract stating that, when
your shares reach a certain value in the future, you will sell
your holdings at this predetermined price. When that price
is reached, the order will be processed and the transaction
completed. Of course, if you ever change your mind about a
limit that you have set, you can place a stop order with your
broker, which designates that you no longer wish to trade at
the specified dollar amount.
You can also buy on margin. This is very similar to short
selling, but instead of borrowing stocks to sell, you are
essentially borrowing money to purchase stocks on your own
when the market value is down. Then, when the value of
the securities you have purchased rises and you are able to
sell for a profit, you repay the loan and keep the excess
from the sell, minus the broker fees. Of course, all dealings
with a stockbroker incur a premium, or fee for services
rendered, and it is nearly impossible to trade without a
broker or broker service. However, online services are often
less expensive than live agents, but you can research to
determine what your best option is.
How Do I Handle a Whipsaw?
No, we are not referring to anything in the garage, the
bedroom, or a country band. A whipsaw is market trend
that defies the odds. It can be thought of as the “fender
bender”. Despite how careful you are as you learn to drive a
car and become coordinated, sometimes you cannot do
anything to avoid being rear-ended.
Whipsaw is a term for what happens when everything points
toward a specific direction in market trend, causing you to
buy (if it looks as though prices are going to rise) or sell (if it
seems they are about to fall), then the opposite effect
occurs.
For example, if you purchase a security at five dollars per
share because the stock seems to have fallen as far as it can
go and appears to be starting an upward trend, then
unexpectedly, the stock plummets to one dollar per share,
this is considered a whipsaw effect. If this happens to you,
as it surely will if you play the market long enough, the best
thing to do is wait it out. The stock will do one of two things
– it will either dissolve entirely, and the company will go
bankrupt (this is what you do not want to happen), or it will
rebound, and you can opt to wait for a chance to turn a
profit or you can get out as soon as the purchase rate is
reached.
Whipsaws are not the end of the world, and no one can
expect to gain with every stock market purchase. However, if you find that you are involved in several of these
instances, you should seriously reconsider your investment
options. You may be reading the signs incorrectly, or you
could be picking bad stocks. You should seek advice for any
future investments you expect to make prior to purchasing
any further stocks or securities.
Another way to overturn a bad investment like this is to
proceed with an offset transaction – a purchase or sell that
offsets the loss of a previous transaction. You could either
purchase additional stock in the same company at the lower
price if you expect it to recover, or you can opt for another
hot commodity that is about to explode in price, either of
which will help you offset your loss. You could also sell
shares of a security in which you have a large amount of
unrealized gain – gain that cannot be measured in liquid
assets or cash due to increase in value of stock and security
holdings – in order to replace the lost cash value.
All of these are viable options to recover a loss, but waiting
for the share value to rebound is always the first choice. It
avoids the loss of funds already invested, retains the option
to pursue profit, and reduces the risk of further investment
into the market.
As you grow and learn about these various options, you will
need to feel more comfortable when surrounded by financial
gurus and geeks who speak what sounds like gibberish, muttering words you have never heard left and right. The
following chapter will take you through some of the
meanings of the major “buzz” words used in the stock
market and the international financial district.