Investec online trading warning

There is a growing trend of self-directed or ‘DIY investing’ among local investors, and while it can lead to excellent returns, having a solid risk management strategy is essential.

This is according to Tinus Rautenbach, head of Investec’s new online trading platform, Clarity.

He advised that investors should ensure they have a few things in place before engaging in online trading.

This includes a comprehensive savings and investment plan that caters adequately for retirement, sufficient allocations to longer-term savings through a pension fund or RA, and emergency savings that cover 3-6 months of living expenses.

Once all these boxes are ticked, investors can allocate some or all of their discretionary funds to execute a trading strategy.

“Investors should view the trading portion of their portfolio as an income stream rather than a long-term investment,” Rautenbach said.

Generally, trading involves making short-term bets on market movements and asset prices over days or weeks to benefit from current trends.

Trading platforms offer easy and cost-effective access to both local and global markets. This allows investors to diversify beyond South Africa and invest in major international companies, foreign currencies and key trends like technology and AI.

“Traders can also access a diverse range of asset classes online through ETFs, which offer broad market exposure across different themes and baskets, without the need to take a specific stock view for an easier way to diversify a portfolio,” he said.

Online trading platforms have improved and now offer advanced tools that allow investors to use leverage, meaning they can trade with borrowed money to potentially earn higher returns. 

Margin trading, a form of leveraging that involves buying securities with borrowed funds from a broker, allows for short-selling. This gives experienced traders more flexibility to profit from changes in market prices.

“However, while using leverage to trade on margin can amplify potential returns, it can also magnify any potential losses, which makes margin trading a high-risk, high-reward activity,” Rautenbach explained. 

Traders should choose strategies that fit their interests and capital, conduct thorough research, and select trades based on their market analysis.

“The next step is calculating the risk-reward ratio in each trade as part of an overarching risk management strategy. The ultimate risk-reward ratio in any trade is strategy-dependent.”

Traders can adjust the risk-reward ratio by either increasing their investment in a trade they believe will succeed or taking a chance on a trade with low chances but high potential returns, like a Black Swan event that could deliver 10x returns.

“Traders who opt to embrace shorter-term trading strategies that aim to make a 1-2% profit on each trade would require a higher ratio to ensure that overall returns exceed total losses.”

Another key risk management consideration in any trading strategy is position sizing, which entails determining the number of units or shares to buy or sell in a particular trade based on the trader’s account size and risk tolerance.

This helps traders decide how many shares to buy or sell based on the entry price and set a stop-loss to limit potential losses.

“The difference between these values indicates the capital a trader is ultimately risking, which should align with their risk tolerance – the total amount a trader is comfortable with and can afford to potentially lose on a single trade.”

“The industry norm is to risk 2-3% relative to the portfolio size of a single trade. Whatever position a trader takes, it is important to understand the proportion of the portfolio they risk on each trade.”

“Based on this risk tolerance, traders should implement risk-mitigation measures to protect themselves from downside risks. For example, they could put stop-loss orders in place that automatically buy or sell a security if the price reaches the identified threshold to limit potential losses.”

Rautenbach said that, ultimately, the key to the success of any risk mitigation strategy is meticulously planning every trade and then sticking to that plan.

“Traders need to adhere to the strategy and stick to their defined entry and exit points by keeping their emotions out of the decision-making process to avoid mistakes like averaging down by adding to a losing position, hoping the price will rebound.”

“In this regard, it is critical that a trader determines their risk tolerance, which relates to their financial and psychological ability to handle large potential drawdowns on capital.”

“In the end, traders who are passionate about the process, have a clear goal, take the time to understand markets, and learn from their trades by keeping meticulous notes will develop the acumen and track record needed to succeed.”