How to manage risks while trading, investing online

If you are trading or investing in any of the capital markets, the risk is certain. Risk management techniques and precautionary measures can bring down the risk factors up to a certain extent but the risk cannot be completely eliminated.

Different types of traders and investors tackle the risk factors differently. Some are more focused on returns while some prefer to protect themselves with a slight compromise on returns.

You can also find traders and investors who completely leave the risk factor on luck.

One cannot simply escape from risk in financial markets. Even if you keep cash in your wallet or locker, you are putting it at risk of inflation.

Money kept as cash will lose its buying power with time due to inflation.

To enjoy the best outcome at the lowest possible risk, traders and investors need to carefully analyze each and every component of risk.

After analysis, they need to find the best possible measures to mitigate it or reduce its effect on the invested amount. The risk to reward ratio is one of the most important factors to consider while trading and investing.

We have discussed few measures that can assist traders in Uganda to mitigate the exposure to risk in financial markets.

1. Planning will Reduce Risk

If trades and investments are executed according to a plan rather than randomly, there is a better chance of positive outcomes.

Traders and investors need to make a strategy, stick with the plan, and keep improvising the plan and strategy at regular intervals.

Successful and experienced traders always trade or invest according to a plan. Seeking profits in financial markets without proper planning is similar to searching for treasure without a map.

The risk factors can be fairly mitigated by planning a disciplined strategy to trade or invest.

2. Never Risk it All

New traders often seem to put a substantial amount of money at high risk. Small gains in the initial stage generally lure the newcomers to put the large amount at risk of capital markets.

Traders and investors should consider all possible outcomes before risking their hard-earned money. They should only invest the amount they can afford to lose in high-risk markets.

• Follow One Percent Rule
Many experienced traders follow the one percent rule in trading to limit the risk factor.

According to this rule, retail traders must never risk more than 1% of their capital or account balance on single trade order. This means that if you have 100$ in your account, you should not open a position worth more than 1$.

• Do not Invest Everything in One Instrument
Never put all your eggs in one basket. Diversification is a proven risk mitigating technique in trading and investing.

If your investment is diversified among multiple instruments, some tools can generate a positive outcome balancing the losses of others.

Diversifying the portfolio in different instruments, markets & countries will reduce the extent of risk. But after some point, each added instrument in a portfolio reduces the expected return more than reducing the risk factor.

• Don’t go Overboard with Leverage
Leverage allows traders to open large positions with smaller deposits. A leverage of 1:100 will allow them to trade with 100$ with a deposit of 1$.

In case of a favourable outcome, traders can enjoy phenomenal returns but if the price moves against anticipation there will be drastic losses.

Due to the involvement of high leverage, sometimes traders end up losing all the deposited amount in their accounts. Traders and investors should use safe leverage. Newcomers should not start trading with leverage until they have decent experience.

• Establish a Maximum Loss Plan
Traders and investors should be certain of the maximum loss they can bear in a trade or investment. Once that point is crossed, they should close their position to avoid bearing further losses.

Many newcomers tend to lose exponentially as they expect their losses to recover in the same trade order. They end up adding to their losses draining all the amount.

3. Calculate and Analyze Risk

Risk in trading and investment can come in due to multiple reasons depending on the instrument selected. Evaluation and analysis of risk can greatly influence the outcome with a low probability of losses.

• Complete Risk Evaluation
To calculate the overall risk involved, one must be familiar with every component of risk. It is important to be familiar with the risk factors to reduce their effect on trade and investment.

Risks in the stock market include market risk, business risk, liquidity risk, taxability risk, regulatory risk, etc. Similarly, risks in forex trading include leverage risk, interest rate risk, transaction risk, counterparty risk, country risk, etc.

Traders and investors should try to consider each component of risk for a complete evaluation of risk associated with financial markets.

• Calculate Risk to Reward Ratio
The amount of money at the risk of loss can be compared with the possible returns from the trade order. The risk to reward ratio represents the relation between possible gains and losses.

Suppose a buy order executed at the price of 200$ has a downside risk of 20$ and an upside potential of 30$, the risk to reward ratio will be 2:3.

This means that for every 3 units of expected return, traders need to take 2 units of additional risk.

Risk to reward ratio of less than 1:1 means for each unit of expected return; traders need to take more than 1 unit of additional risk. Such trade orders must be avoided.

4. Risk Management Tools and Strategies

Various risk management tools offered by the brokers and exchange can come in handy to mitigate the risk factors.

• Stop Loss and Take Profit
Stop loss and take profit are the safety features that automatically close the opened position once either of them gets triggered. Suppose a trader buys EUR/USD that is trading at 1.2000$.

If a stop loss and take profit is entered at 1.1900$ and 1.2100$ respectively, the order will be automatically closed if either of these 2 prices is reached and profit or loss will be booked accordingly.

The stop loss or take profit can also be modified at any instant to protect the gains or limit the losses.

• Calculate Expected Return
Traders and investors should have a slight idea about the returns that are expected from the orders. With fundamental and/or technical analysis, they can also calculate the expected return.

Once the target expected returns are reached, the position can be closed to protect the gains.

Historical returns, benchmark returns, risk-free rate of return, inflation rate, etc. can also be used to get the gist of the expected return.

• Portfolio Management
Investors should always seek to improve the portfolio by reducing the volatility and adding/removing suitable/unsuitable instruments at regular intervals.

The volatility in the portfolio can be greatly reduced by diversification, cost-averaging, and a research-based selection of instruments.

5. Use Right Trading/Investing Platform

The selection of a broker or trading platform is the most important step to mitigate third-party risk. Traders and investors must choose a broker that is licensed and regulated in their local jurisdiction.

Many fake brokers and agents in various capital markets seek to take unethical financial advantage of investors.

Nigerian Exchange (NGX) and Securities and Exchange Commission (SEC) are the capital market regulators in Nigeria.

Investors can trade instruments like equities, debt instruments, derivatives and ETFs at NGX licensed trading platforms.

Investors in Nigeria, must look for and only choose stockbrokers & trading firms that are licensed by Nigerian Exchange Limited (NGX), these brokers offer debt instruments, ETFs and equities listed on NGX.

While South Africa which has the largest financial markets in Africa, there are two major regulators namely Johannesburg Stock Exchange (JSE) & FCSA that issue regulatory licenses to brokers and oversee their compliance.

And these brokers can offer wide variety of instruments from equities, debt instruments, commodities to derivatives. African investors from other countries also can trade with FSCA regulated brokers with safety of FSCA.

Apart from above major speculative trading Instruments like CFDs and Forex that are popular in Europe are not yet regulated in most African nations.

Only two regulators i.e.: South Africa’s FSCA and Kenya’s CMA have regulated CFDs and have issued licenses to Forex Brokers to offer trading on currencies, indices, international stocks, commodities, metals, bonds & ETFs.

Due to which CFD traders in most African nations often choose offshore brokers. South African regulated forex brokers are often first choice of many African traders for these instruments and now CMA regulation has also gained reputation among traders.

Investors must always look out for regulation and jurisdiction of their brokers/trading platforms for their safety. Brokers regulated under local regulation of own country are considered safest.

But if you still want to choose offshore broker then check that it is regulated by reputed/top tier regulators of other major countries like FSCA of SA or CMA of Kenya or FCA of UK.

Apart from regulations, traders and investors should also check the fees, trading conditions, available instruments, deposit/withdrawal methods, and available features at the trading platform.

6. Protect Your Devices

The device used for trading and investment can be at the risk of malicious cyber-attacks.

PC, smartphone, and tablet devices used for trading and investment should have anti-virus software to mitigate the risk of third-party cyber-attacks.

The login credentials should not be shared with anyone. Features like 2FA login, fingerprint, and facial recognition can further reduce the risk.

Traders and investors should use a secure internet connection and shouldn’t use public or open Wi-Fi.