Personal Wealth Creation - Risk Management

Investment Risk Management: Underestimating investment risk will harm the investor, where as overestimating it will prevent an investor from implementation of bold investment decision. Risk is measuring the probability of loss in an investment. There are many ways to manage risk when you invest in the stock market. The following are some of the strategies professional investors follow to minimise their risks.

Diversify - Don't put all your eggs in one basket. Minimum 10 to 30 stocks in your portfolio.

Limit your losses - Use stop loses mechanism to protect your capital and available funds.

Liquidity trap - Buy only liquid investments. Liquid investments are those that can be sold whenever you wish to convert them into cash.

Psychology trap - Trade with your "risk" capital only and investing in businesses that you understand. Never borrow funds to trade or use the funds kept aside to meet your daily needs.

Risk is inseparable from return. Every investment involves some degree of risk, which can be very close to zero in the case of a U.S. Treasury security or high for an investment in equities.
Understanding Beta: Beta is one of the most used and misused of the financial ratios. The beta is a measure of a stock’s price volatility in relation to the rest of the market. In other words, how does the stock’s price move relative to the overall market.
The number is calculated using regression analysis. The whole market, which for this purpose is considered the S&P 500, is assigned a beta of 1. There is no single index used to calculate beta, although the S&P 500 is probably the most common proxy for the market as a whole. Stocks that have a beta greater than 1 have greater price volatility than the overall market and are more risky. Stocks with a beta of 1 fluctuate in price at the same rate as the market. Stocks with a beta of less than 1 have less price volatility than the market and are less risky.
Beta and Risk: Of course, there is more to it than that. Risk also implies return. Stocks with a high beta should have a higher return than the market. If you are accepting more risk, you should expect more reward. For example, if the market with a beta of 1 is expected to return 8%, a stock with a beta of 1.5 should return 12%. If you don’t see that level of return, then the stock is not a good investment possibility.
Stocks with a beta below 1 may be a safer investment (at least by this one measure) and you should expect a lower return.
Beta seems to be a great way to measure the risk of any stock. If you look at young, technology stocks, they will always carry high betas. Many utilities on the other hand, carry betas below 1.
However, you should always remember as a single predictor of risk for a long-term investor, the beta has too many flaws. Careful consideration of a company’s fundamentals will give you a much better picture of the potential long-term risk.

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Preserving your Capital - Capital Protection Techniques It is a well known fact that nobody can predict the future trend of the market. Based on information, facts, fundamental analysis and technical analysis we can make a informed guess on what can be the future trend of the market. This kind of a guessing works better when the trading is for a long term period. It is verify difficult to predict if say you execute a trade at 9am and plan to exit the trade by earning a profit at 10am. Even seasoned players in the stock markets prefer trades where they can hold on for a longer period and wait for the prices to move in the expected direction.

Remember, for a trader his most valuable asset is his trading capital. The most important rule for him is to “Preserve his capital”. To preserve his capital there are many rules, for both short term trading and long term trading. More than anything else a trader should have a trading plan. The plan should be, preferably, a tested plan. A plan can be tested by back testing. You take the data for the past couple of months and run it thru your plan. If it gives you a sizeable profit or a return that is as per your plan then you can confidently apply this plan for your trading. Plan’s should not be considered as sacred documents that cannot be changed. You have to keep watching the markets, your performance and any changes that are happening in the trading environment. Based on this you should keep updating and changing your strategies and your plans.

Have you thought over why so many stock traders fail and only a few keep winning. These winners not only preserve their capital but also make a sizeable profit regularly. It is because many stock traders do not follow the rules. Successful stock traders cut their losses short and move on to the next trade. Also they hold no grudges against any one, neither the market nor themselves. Losers hold on to falling stocks mostly because of psychological issues until making a rational decision has long since gone from their control. You need strong inner strengths to become a winner in the stock market. It is not difficult. All that you need is discipline and a trading plan to follow. Forget your ego and follow your trading plan in an objective manner and become one of the few successful traders.