Ajitansh Kar, Gurugram, 20 December 2022
While placing trades on the screen, I have this constant urge to place an order that is bigger than my intended size of investment or my risk appetite in the hope of making more money, provided that the trade plays out in my favour. But the subconscious mind is unaware or does not think about a scenario where the trade can go the other way round. This is where risk management comes into action and helps you not blow up your entire savings and make you bankrupt.
Before understanding the importance of risk management, it is important to understand what risk means and why is it so important to asses risk before blindly punching in a trade or buying any security for that matter. A risk is to be understood as an event which is unfavourable for you and is potentially dangerous. In stock markets risk can be of many types; but are generally associated with the price of your stock declining. To asses risk one must be aware what he is getting into and factor in the maximum amount of loss he can bear. There are hundreds of thousands of risk management techniques; typically, the simplest of all is putting a stop loss. The term stop loss is self-explanatory and deals with the level (price) at which one must exit his or her trade or position in order to minimise the realised loss.
Many novice traders aren’t willing to devote time towards learning risk management. They are willing to focus more on learning the best strategies and indicators and trying to find the holy grail of trading. In reality, there is no holy grail in trading and your chance of succeeding in a profession like trading boils down to your psychology and risk management. This does not mean that your strategy does not play a part in your trading journey, only that, in my experience, I have found out that 80% of your success comes through following proper risk management techniques and having a strong mindset.
I always like to explain the importance of risk management through a small example. Suppose I come up to you with a scheme and offer you a rupee for waking up at 7:00 am each day for the next 10 days. However, if you wake up late on any of the days during the continuation of the scheme, I would take away all the money you earned plus levy a penalty of two rupees. That might seem like a fair offer to you and you may accept it happily. Things go nicely for the next 9 days and you have earned a total of nine rupees. On the 10th day, instead of giving you a rupee more, I take away eleven rupees from you because you woke up 5 minutes late. At the end of 10 days, you are left with a loss of two rupees even though you were benefiting from the scheme till the previous day.
The exact same thing happens to new traders too. They are more obsessed with winning all the time than on winning more at a time. This is purely a result of poor risk management and fear of missing out (FOMO).
Now let’s take the same example as above but change the details a bit. This time I offer you ten rupees for waking up at 7:00 am everyday and would take away a rupee for not completing the task on any particular day. Under this scheme, even if you wake up on time on three out of the ten days, and sleep till late on the other seven days, you would have still made a profit of twenty-three rupees.
This would have given you a clear idea on how important risk management is and why it is necessary to implement it. Understanding your risk better and managing it is the only way you are going to beat the remaining 99% of the traders present in the market.
