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Risk Management in trading and investing

When trading in the stock market, one of the key things any trader must focus on is risk management. While risk management is a term frequently used in investing discussions, understanding it based on a person’s psychology and mindset is crucial.

Not everyone shares the same mindset, and the perception of loss varies for each individual. The loss we refer to is the notional loss, reflected in an open position but actualized only upon closing it. One trader might feel uneasy seeing a 5% notional loss and immediately close their position, booking a loss. In contrast, another trader might endure a higher percentage of notional loss, holding the position until it turns profitable or minimizing the loss.

Risk management involves setting these thresholds when taking trading positions. These limits differ for each person, and the challenge is for individuals to identify what suits them best. Many attempt to emulate others without realizing that what works for someone else might not suit them. For instance, mimicking the investing styles of ‘shark’ investors based on publicly available data can often prove detrimental. The shark investor may have a much higher tolerance for notional loss compared to an individual, and the invested amount might be insignificant within their overall portfolio.

This leads to the question of how much an individual should invest per position, especially if the intention is to hold the position for days or weeks. Given the limited investment corpus, the number of positions an individual can take up is determined by their risk management approach.

With a restricted investment corpus, it’s crucial for investors to judiciously spread out available funds. Consider an investor with Rs 5,00,000 for short-term investments. It’s advisable to divide this equally among investments based on their risk appetite.

For instance, Investor A might be comfortable witnessing or booking a notional loss of up to 10%. In this case, the Rs 5,00,000 would be split into ten positions of Rs 50,000 each. Each investment’s loss would be capped at 10% of its value, i.e., Rs 5,000.

On the other hand, Investor B might become anxious with a 5% notional loss. For such an investor, the Rs 5,00,000 would be divided into twenty positions of Rs 25,000 each. Losses capped at 5% would amount to Rs 1,250 per losing position.

For both A and B, profitability relies on the winning positions outnumbering the losing ones. Assuming both invested in Univest’s short-term ideas with an accuracy of 89.5%, A would have one losing position, and B would have two losing positions out of the amount invested.

Ultimately, it’s up to individuals to identify where they fit and navigate a profitable investment journey, managing risk according to their own personalities.



Ketan Sonalkar (SEBI Rgn No INA000011255 )

Ketan Sonalkar is a certified SEBI registered investment advisor and head of research at Univest. He is one of the finest financial trainers, with a track record of having trained more than 2000 people in offline and online models. He serves as a consultant advisor to leading fintech and financial data firms. He has over 15 years of working experience in the finance field. He runs Advisory Services for Direct Equities and Personal Finance Transformation.

Note – This channel is for educational and training purpose only & any stock mentioned here should not be taken as a tip/recommendation/advice

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