Stock Portfolio Risk Management – Understanding the Strategy
You might have read our tutorial on Risk Management in Stock Trading:,which is a very important skill you should learn in order to become a successful trader.
Now, to move forward –> assuming you start trading a variety of diversified stocks. You are now starting to create a stock portfolio. This is both good and bad news for you as a trader.
First, the good news is that you will have a chance to increase the learning potential of your portfolio by adding diversified set of stocks.
Second, the bad news is that managing stocks portfolio is very risky and instead of achieving your learning potential, it can even result to greater losses.
Let’s solved the bad news and turned it to good news. You will be happy that a solution exists. This is called stock portfolio risk management. This technique when followed religiously can prevent massive losses in your trading capital and instead turn these losses into a long term earning potential.
Stock portfolio risk management should be part of the money management strategy of stock trading. Let’s illustrate the principle:
Let:
PortfolioTotalRisk = the total amount of risks in your stock trading portfolio.
Stockrisk1 = the %risk of your first stock.
Stockrisk2= the % risk of your second stock
Stockriskn = the %risk of your nth stock
Therefore:
PortfolioTotalRisk = Stockrisk1 + Stockrisk2 + … Stockriskn
Where Stockrisk1, Stockrisk2 … Stockriskn are computed and discussed thoroughly in this tutorial: http://www.stock-trading.me/2010/05/risk-management-in-stock-trading/
Recommended Strategy:
Beginner Traders should not handle more than 10% of the total portfolio risks; although if you are very conservative trader you may even target less than 5%.
Why there is a need to limit risk? In stocks, past performance is NOT indicative of future results and stock trading is a risky form of investment. By limiting risk, you are also limiting losses which maximize your earnings and the life of your stock trading portfolio.
Related posts:
- Risk Management in Stock Trading
- The Principles of Money Management in Stock Trading
- Kelly Criterion Investing: Calculator and Strategy
- Trading for a Living, Psychology Trading Tactics Money Management – Book Review
- Stock Exit Strategy: Formulating an Effective Profit Targets