How to manage risks while investing in share markets?

The stock market appears intimidating for many as it is perceived as a speculative business with no certainty of return. It is, thus, widely misconstrued for gambling or betting. The myths surrounding the stock market in India act as a catalyst creating fear of investing and trading.

Common misconceptions hamper potential investors/traders from learning and gaining from the stock market - be it you can only make money by investing huge chunks, expert advice is a must, or high risk means high return.

However, this trend is reversing.

According to Securities and Exchange Board of India (SEBI) data, investors opened a record 7.2 million Demat accounts in Q12021. Often, traders fail to understand the importance of risk management, resulting in resistance towards stock trading and investing. With the help of risk management techniques, you too can utilize the wealth creation potential of the market.

It’s widely said that ‘history repeats itself.’ Maintaining this belief, technical analysis studies the stock price movement and predicts its behavior. It presents a pictorial representation of price history, making it easier to capture the market reactions.

The price and volume information will help you determine indicators such as moving averages, relative strength index, Bollinger bands, etc. These technical indicators will acquaint you with the potential risks involved, and you will be in a better position to minimize them or even turn them into profitable holding positions.

One of the most important ways of managing risk is to diversify your portfolio. It means to put your money prudently and judiciously in stocks with varying volatility and unrelated themes. When you divide funds with the expectation that the positive performance of some will offset the negative performance of others, you minimize the risk posed at you by one set of stocks.

The goal of diversification is to reduce the risk. If you invest in things that do not move in the same direction, simultaneously, or at the same pace, you potentially reduce your chances of losing all of your money.

The risk-reward ratio acts as a measure to compare the probable returns out of a particular investment/trade to the amount of risk an investor takes to get these returns. To assess the ratio, you need to divide the risk - the amount the investor will lose - if the price moves negatively by the reward - the investor’s profit when the position is closed. You should also maintain a ratio where the potential loss over the investment need not be higher than any predictable profit.

Over the past few years, along with the increasing number of retail investors, there has also been an increase in unsolicited stock tip messages, calls, and websites. These are dubious schemes by tipsters where they pick illiquid stocks which typically are not actively traded. The prices of these stocks go up as people flock in with the circulation of messages.

As the price keeps going up, these tipsters keep offloading the stocks in large quantities. Sooner or later, they start hitting lower circuits for months, leaving investors trapped.

You should never invest or trade based on anonymous and fraudulent stock tips. Most of these stocks are window-dressed and illiquid. Always stay away from trading or investing, based on stock tips, messages and calls. If you receive such calls or messages, report them on SEBI and the Exchange tiplines.

Different traders can analyze the same charts from a different perspective, and this is because of the varying psychologies. In the stock market, when someone is buying the stock and the other is selling it, both think they are right. Often traders get emotionally attached at the time of entering a position. It may happen because when traders put more money at stake, the fear of losing money rises.

In such circumstances, the only way to manage your capital is to pre-define the risk, pre-plan, and prepare yourself for losing. Remember, you can lose any trade. There is an element of uncertainties for any given series of transactions. However, capital management is the only thing that will save you against all odds and help you succeed in the long run.