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What is Market Risk Management?

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  • Written By: Jim B.
  • Edited By: Melissa Wiley
  • Last Modified Date: 16 March 2018
  • Copyright Protected:
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    Conjecture Corporation
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Market risk management refers to the process by which individuals attempt to lessen the risk involved in investing in the stock market. This is a crucial technique that investors of all levels of wealth and experience must learn to protect their capital. In terms of the types of investments made, market risk management demands diversification of an investor's portfolio across all sectors of the market. Manipulating the amount of capital in each investment, known as position-sizing, and installing stops in investments to prevent big losses are two other ways to mitigate risk.

Many people wish to try out the stock market as a way of building wealth both for the short-term and for years in the future when they're ready for retirement. The drawback is that no investment opportunity is risk-free, and no investor wants to see hard-earned money disappear into the stock market without any possible return. For this reason, learning market risk management is crucial for any investor before proceeding to enter the market.

One proven method of market risk management is building a portfolio that consists of many investments spread among several different sectors in the market. For example, an investor who puts all of his money into energy securities could suffer a huge downfall if that sector takes a significant hit. Making multiple investments across the entire spectrum of the stock market means that an investor's portfolio would be protected if one or even a few investments struggle.

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Position-sizing, which is the term for how much capital an investor puts into each of her individual investments, is another proven method of market risk management. The idea behind this strategy is that an investor should try to assign the capital within her portfolio according to the strength of the investments within it. It makes sense for an investor to put her capital behind the stocks that are performing the best, a technique that allows the investor to simply react to the market instead of trying to predict it.

In terms of individual investments, market risk management can be achieved by installing stops in orders given to investment brokers. For example, an investor who buys a particular stock at $30 US Dollars (USD) per share might institute a stop at $25 USD per share, which means the stock broker would sell the stock once it reaches the $25 USD level. Doing this allows an investor to mitigate the losses from a particular stock that takes a huge drop.

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