One of the reasons, why people can’t make money in the stock market , is they don’t manage the risk well. In stock market, the very first thing is to survive till the very
long , after that comes the part of adequate return on your
capital.
“ An investment operation is one which upon
thorough analysis
Promises the safety of capital and an adequate return.
Operation not meeting these requirement are speculative. “
Benjamin Graham
People usually think of risk as volatility (prices up and
down) in the stocks and other financial instruments. But it
(risk) is the permanent loss of capital. In todays time, there are
glut of information available on any stock or any other product
in which one wants to invest. But there are still some
unknowable which one cannot make out despite ones hard
research efforts. So there will be always uncertainty upon the
future prospect on any given investment one make.
One needs to consider the scenario of a given trade going
against ones expectation and take into consideration how much
one can loose in that scenario and also consider before bet that
how much one can afford to loose. The loss will not be in any
scenario that much which hardens ones survivability in the
market. Often the people run after the returns. In chase of
returns, one does not think about the risk which one is taking.
Risk management is very important if one is into the
investment business.
In risk management , one needs to analyse each idea with the
perspective of risk reward ratio. Of course that is not exact but
it will give the rough sense about risk reward in any given idea.
Firstly, to think in this way, one must have the modesty to
accept that one can go wrong. One should understand there
will not be in any case one have all the information to take
decision with 100 percent certainty. There will always be some
unknowable.
To avoid the risk ( permanent loss of capital) in times of
uncertainty , one should approach very probabilistically , there
is never one answer like right or wrong , there is always that
this is more likely right and more likely wrong. It is always be
better to roughly right than to be precisely wrong.
After following the process which you use to analyse a given investment,
next question should always comes that what percentage of
one’s portfolio should be allocated to stock. For the novice
investor , it would be good if he/she not invest more than like
5 percent of his/her portfolio in any given idea. As the time
passes, with experience and learning one can do allocation on
the basis of conviction in the particular stock. More the
conviction more can be allocated but considering the scenario
of risk (permanent loss of capital) if bet does not work out. ( It
is better if the conviction is backed by the hard facts more
rather than the future rosy picture)
If the stock does not work out the way you expected, one
should be quick to cut the losses instead of waiting for stock to
perform in the way one’s expected.
One should have that modesty to accept that one is wrong
and should be get out of the stock to avoid further impairment
in the capital. Even the best traders/investors have success ratio of less than 60%.
People focus more on making higher returns rather than
avoiding bigger losses. One should be more focused on avoid
losses that way also one can earn adequate returns in the
markets.
Risk management is about the allocation one should do in
any particular idea with the perspective of risk reward ratio.
Reward should be at least 2-3 times of the risk you want to
take. Risk should not be that much which put you out of the
stock market. And in the idea which does not work out in
favour , one should be quick to recognise and be out of stock.
In this way, one can ensures ones longevity in the markets
and can compound the capital for very long time.
Argha Investment Advisers 