RISK MANAGEMENT FOR STOCKS
Plain English
Risk management is how you protect yourself from big losses. The core rules: never risk more than you can afford to lose, use position sizing to limit each trade's impact, set stop-losses, and diversify across different stocks and sectors.
Going deeper
Risk management is the most important skill in investing. Key principles: Position sizing — never put more than 5-10% of your portfolio in a single stock. Stop-losses — predetermine your maximum acceptable loss on each trade. Risk/Reward ratio — only take trades where the potential reward is at least 2x the potential risk. Diversification — spread across sectors, market caps, and asset classes. Correlation awareness — owning 10 tech stocks isn't true diversification. Maximum portfolio drawdown — decide the maximum total portfolio loss you can tolerate (e.g., 20%) and adjust position sizes accordingly.
Examples
Position Sizing
Portfolio value: $100,000. You want to buy a volatile biotech stock. Rule: max 3% per position. You invest $3,000. If the stock drops 50%, you lose $1,500 — 1.5% of your portfolio. Painful but survivable.
Risk/Reward Ratio
You identify a trade: entry at $50, stop-loss at $47 (risk = $3), target at $59 (reward = $9). Risk/Reward = 3:1. Even if you're only right 40% of the time, this trade is profitable over many repetitions.