How does the risk of loss arise?
The market is unpredictable and we should know that every investment carries some risk of loss. This arises when the value of an asset falls or the market moves in the opposite direction to our expectations. This effect can be caused by several factors. For example, it can be a change in the political environment caused by elections, economic events, but also statements made by influential personalities.
Limiting the risk of loss
Naturally every single trader wants to know the ways to best prevent the risk of losing financial capital. One of the frequently used ways is the Stop-Loss order, which you can set directly on the trading platform. It is a compensating order that will terminate your trade when a certain price level is reached. With Stop-Loss, you can close your trade at the exact moment when the market price moves above a pre-selected level.
Example:
If a trader buys a stock at $20 and enters a Stop-Loss order at $19.50, his Stop-Loss order will go through just as the price reaches $19.50, preventing further loss. If the value never drops to the $19.50 level, this type of order will not be executed.
Through diversification to reduce the risk of loss
One trading strategy that is used to reduce the risk of loss is diversification. This is the composition of investments into a number of baskets of assets in order to reduce investment risks. Diversification is also a tool that is suitable for maximizing returns over the long term. Not only is it an excellent and most commonly used tool to reduce or limit the potential amount of loss, but it helps traders achieve better goals over the long term. Over the duration of an investment, different asset types behave differently. This means that a diversified portfolio that includes different investment classes - equities, indices, real estate, or commodities - tends to have higher long-term returns.
Hedging strategy
The aim of this hedging strategy is to reduce or limit the losses that arise from fluctuations in the values of investments, i.e. to lock in profits in some way. This strategy works on the principle of offsetting. We can hedge against financial risks by offsetting a position against a position in an asset. In other words, by buying an instrument whose value would rise if the value of the underlying asset being protected were to fall. With a hedging strategy, traders seek to insure against a negative event.
