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Highlights
- Losses cannot be avoided in financial markets is one of the drawbacks that comes with the uncertain nature of the market.
- While it’s impossible to avoid risks and uncertainty in the market, there surely are ways to help minimise risk.
- Stop loss orders are essential to cut your losses short and cap them within your risk allowance.
As stock markets move in a straight leg-up, market falls or corrections are inevitable parts of an investment journey. However, not every investor is able to handle stressful periods of drawdowns and it surely does not mean to liquidate your holdings and step aside.
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While it’s impossible to avoid risks and uncertainty in the market, there surely are ways to help minimise the risk and protect capital during market corrections. Let us have a look at three strategies that can help you protect your portfolio from going to the dogs when the tide turns against you.
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- Diversification
Diversification is the cornerstone of a successful investing journey. It simply means to allocate your capital to different sectors within equity markets or different asset classes altogether to minimise the risk of one asset/sector on the entire portfolio. It eliminates the concentration of risk from one asset to the entire portfolio.
Worried about market fall? Here’s how to protect your portfolio
This helps in reducing portfolio drawdowns during the market correction as all the sectors/assets in the portfolio are unlikely to fall at the same time. However, too much diversification may also hamper returns.
- Hedging
Hedging is a strategy wherein investments in two assets are made which are inversely co-related to each other, meaning if one asset falls in value, the other one tends to rise. This helps to mitigate risk as losses from one asset are offset by gains in the other one.
However, the degree of hedging varies, and investors need to be cautious as to how much effective hedge one wants to create. For eg., one could buy put options against their holdings, but the selection of the strike price of the put option will determine how much profit you will reap in case your holdings decline.
- Use Stop loss
A stop loss order protects your securities from falling more than your permissible price. For eg., if you have bought a share at AU$100 and have a risk appetite of AU$10 on this position, then you can place a stop loss order at AU$90. So, in case your share falls to AU$90, your holding will be sold off protecting you from a further loss below AU$90.
Stop loss orders are essential to cut your losses short and cap them within your risk allowance, therefore not allowing any of your holdings to make a severe dent on your overall portfolio.
Bottom Line
Losses cannot be avoided in financial markets is one of the drawbacks that come with the uncertain nature of the market. However, with proper risk management strategies, most of which are easier to deploy, investors can definitely minimise the risk within their capacity to bear.
Measures such as diversification and hedging, etc., not only help to reduce severe losses but also help to generate peace of mind and emotional stability during tough times.
