1) View Your Portfolio Holistically for Long-Term Viability

According to Alexander Lowry, a finance professor at Gordon College, it’s essential to view your portfolio as an integrated whole rather than just a collection of individual trades.

He emphasizes:

> “A key insight from professional investors is that individual stock selection is less significant over the long haul. What truly matters is how you allocate your assets. It's not merely about which stocks you buy; it's about the timing of your purchases in relation to bonds, cash, gold, and real estate.”

Numerous studies indicate that how you allocate your assets is far more critical to your overall returns than simply choosing the right stocks or bonds. This is why many top investors leave stock picking to analysts and concentrate on asset allocation.

Conversely, most individual investors neglect asset allocation, remaining fully invested in stocks and often lacking knowledge about bonds—an essential aspect of allocation. They also frequently mismanage position sizes.

Consider this in terms of risk management: diversifying your investments prevents overexposure to any single asset. For example, investing 50% of your assets in Bitcoin may be too risky given its volatility.

Effective asset allocation involves assessing how much of your wealth is in various asset classes, such as cash, stocks, precious metals, and real estate. The primary goal is to mitigate excessive risk in any one class, as when one asset class declines, others may rise, helping to buffer against financial setbacks.

2) Implement Stops to Mitigate Losses

Nate Masterson, a financial consultant, advocates for the strategic use of stop-loss orders to manage downside risk.

He remarks:

> “Utilizing stop losses is one of the simplest yet most effective ways to guard against the uncertainties of a volatile market. Knowing how to apply them based on the specifics of the stock or commodity you’re trading can significantly shield you from losses.”

While the concept of a stop loss is straightforward, the skill lies in customizing it for each trade, which requires market experience and a nuanced understanding of the factors that may influence each trade, from sector developments to global events.

The aim of a stop loss is to exit a position before incurring substantial losses. Setting a loss threshold—typically a percentage of the purchase price—helps determine when to sell. Experience plays a crucial role in deciding these thresholds, as certain stop-loss strategies may work better under specific market conditions.

Masterson advises that you should analyze recent trends and relevant news before setting your stop loss, ensuring it is both well-informed and practical.

Stop losses should be a fundamental part of your risk management approach, whether executed through your broker or integrated into your trading platform.

3) Utilize Trailing Stops to Secure Profits

In addition to static stop losses, consider employing trailing stops. For long positions, this mechanism allows the stop loss to move upward with the asset's price, locking in profits while safeguarding against downward shifts.

Marc Lichtenfeld, Chief Income Strategist at the Oxford Club, shares:

> “We recommend a 25% trailing stop, advising investors to allocate no more than 4% of their capital to any single investment. This strategy ensures that if the stock declines by 25%, your maximum loss is only 1% of your portfolio, a manageable amount.”

He also suggests adjusting the stop every time the stock reaches a new high to protect gains and prevent substantial losses. Furthermore, setting stops on a closing basis rather than intraday helps reduce the risk of being prematurely exited from positions due to temporary market fluctuations.

> “A stock closing at or below your stop level indicates a genuine downward move rather than just market noise.”

4) Correctly Size Your Positions to Manage Risk

Position sizing is a vital element of risk management. When executed properly, it minimizes significant drawdowns while still allowing for profitability.

Lowry asserts that appropriate position sizing is:

> “One of the most critical decisions you’ll face as an investor, especially during volatile market conditions.”

Carter Johnson, founder of UBL Holdings, recommends the Kelly Criterion model for determining position sizes. This model suggests that the size of your investment should correlate with the anticipated outcome, factoring in both potential gains and losses.

> “The Kelly Criterion Model has been utilized by some of the greatest investors, helping to calculate the optimal capital allocation for specific outcomes while also managing overall portfolio risk.”

While we won't delve deeply into the Kelly Criterion here, further exploration of Johnson's insights is highly encouraged.

5) Use Covered Calls to Lower Downside Risk

Mike Scanlin, CEO of Born To Sell and an expert in trading covered calls, suggests this method for reducing the risks associated with holding stocks and ETFs.

He explains:

> “A straightforward approach to mitigate the risks tied to stocks while enhancing cash flow is by selling call options against your shares regularly. This strategy, known as writing covered calls, provides income while capping potential upside. However, with consistent application over time, it can lead to improved risk-adjusted returns compared to a buy-and-hold strategy.”

While Scanlin focuses on stocks, this technique can also be applied to other asset classes, including cryptocurrencies, despite the challenges posed by limited options trading platforms in the crypto space.

Now you have insights directly from industry professionals. Many of these strategies may seem theoretical, but they are practical and effective.

The core components of a robust risk management strategy include:

• Stop losses
• Appropriate position sizing
• Asset allocation

While the covered call strategy may be more advanced, it is worth exploring for those ready to engage in more complex tactics.

> “The elements of good trading are: 1) cutting losses, 2) cutting losses, and 3) cutting losses. If you can adhere to these three principles, you stand a chance.” — Ed Seykota

As the legendary trader advises, PROTECT YOUR CAPITAL.

These strategies focus on safeguarding your portfolio from losses. While they may not directly enhance profits per trade, they will likely contribute to increased overall monthly and yearly gains by minimizing the impact of larger losses.

If you have additional risk management strategies, feel free to share them in the comments!

DISCLAIMER: The information presented in this article is for educational purposes only and should not be construed as financial advice. Always make your own decisions regarding risk or consult a qualified financial advisor.