If the buying and selling of stocks for profit is an art, then risk management is the background setting for the portrait. Protection for when the market turns against an investor’s position should never be overlooked or discounted, no matter how secure the stock, or any asset for that matter, may seem to be for the future. As John Breit, the former top risk manager for Merrill Lynch once stated, “If it’s profitable and seems riskless, it’s a business you don’t understand.”

The easiest way to practice risk management is not to use leverage. If no money is borrowed to buy stocks, then there will never be any fears of a margin call. That can protect the trader from the most dreaded of events in the financial exchanges: the margin call from the broker as the account value has dipped, so additional cash is required. If that does not come immediately, the securities are sold until the margin level needed is met.

But no one trades stocks expecting a low and in anticipation of a margin call.

As a result, leverage will always be utilized in the form of borrowing on margin. At present, it is approaching record levels again with margin debt soaring after The Great Recession. With so much debt-based liquidity flooding the market, risk management must then be practiced through the utilization of hedging.

Hedging is the establishment of a position to protect another holding. It can be very simple: if a trader is long on a stock, then a short position or put options might be maintained as a hedging function. Should the price of the equity fall, than the short position or the put option will rise in equal value. From that basic technique, the long position is effectively hedged.

Needless to say, there are far more sophisticated hedging tactics and strategies, especially with online trading of financial vehicles. As with all trading, the hedging utilized can seek to protect profits for short, medium, or long term periods.

Online trading is particularly valuable for the individual trader seeking to profit in the short term. Hedging positions can be set well in advance with buy or sell orders on a security. It can be simple, such as purchasing a put option that is soon to expire to serve as a short term hedge for a long position.

Or a series of co-relation trades can be established.

As an example, if the price of oil rises, then the price of shipping stocks will generally fall. That is due to fuel being about 40% of the expenses for a shipping company. High oil prices depress economic activity, which decreases the value of shipping stock shares, too, due to fewer goods being transported to overseas markets. As about 70% of the price movement for a security is due to the direction of the sector, a trader could buy exchange traded funds for stocks for individual companies to hedge, too.

So when a barrel of crude rises in price, so should the exchange traded fund for oil, United States Oil (NYSE: USO). At the same time, the exchange traded fund for the shipping industry, Guggenheim Shipping (NYSE: SEA) should drop. The chart below shows that relationship.

Online trading greatly facilitates the use of hedging in risk management. It removes the human element, which is always the most inefficient variable in a trading calculation. Hedging through online trading to bolster risk management should result in greater gains from buying and selling financial products.