While choppy markets can throw out trading opportunities, Joe McGrath asks what is the best approach to minimise risk?
Given the current market conditions, traders certainly need to be vigilant taking any positions. Whether spread betting, foreign exchange margin trading or simply buying shares directly, those trying to generate strong investment performance shouldn’t automatically assume that this will be best achieved by taking large levels of risk. While riskier investments have the potential to perform very well, there are numerous examples outside day trading circles where the top performing sectors have illustrated huge volatility.
Look no further than the world of fund management where the top performing sectors have been China, technology and telecoms, Asia Pacific and emerging markets. Chinese funds fell by a massive 32 per cent in 2008 and 22 per cent in 2011 – and these are supposedly managed by experts who are paid to monitor your assets on your behalf.
Of course, what this does show is that if you invest in high-risk areas at the wrong time, they can leave a big hole in your finances, so researching your individual markets prior to taking a massive leap of faith is key. After all, if seasoned fund managers can take a hit of this size, it is perhaps no surprise that the “burn rate” for novice retail traders remains very high in the UK.
Even if you take an aggressive approach and tie your money up for more than 10 years, don’t hold everything in equities
Financial planners will tell you that once you have decided where to invest, you need consider your financial circumstances before going any further as well as your financial objectives, including how long you want to be exposed for and the level of risk you are comfortable with. As with any investment, a canny investor knows to keep some spare cash back to cater for short-term requirements or emergencies. Essentially, this means you will be able to avoid having to sell out of positions at the wrong time or take on additional debt in order to invest.
Patrick Connolly, head of communications at financial planning group AWD Chase de Vere, says even if you are willing to take an aggressive approach and can tie your money up for more than ten years, you should still not hold everything in equities. He explains: “You may, for example, hold 70 per cent in equities, 10 per cent cash, 10 per cent fixed interest and 10 per cent property. You shouldn’t hold more than 20 per cent of your portfolio in a specific high-risk region.”
Retail traders spread betting for the first time should also remember that they are particularly vulnerable as they are in unfamiliar territory. It is for this reason that industry advice is to only commit small sums initially.
Brenda Kelly, market analyst at CMC Markets, says while it is quite easy to get swept up in the excitement, large gains come with practice and a more methodical approach. She says: “It can be titillating to see large gains, but it is not a proper foundation for longevity, particularly if you are a novice. A novice trader will tend to make his or her worst mistakes early in their career, so it is much better to learn with smaller losses.”
Ultimately, the best way for new traders to minimise their risk is not to over-extend and trade amounts which could lead them to be in excess of their account size. Stick to this golden rule and there are plenty of gains still to be made.