Fear stops learning
There's always a balance in how far you let something go. While I am a relative newcomer to training helicopter pilots, I have 20 years training folks in performance-motor skills (which incorporate a fair amount of possible hazard).
If you let your students scare themselves (even if YOU knew it wasn't particularly dangerous), you inhibit their learning as well as reduce their motivation. The hover is a perfect example of this: a new pilot starts getting into PIO, long before it gets to the point where the CFI is concerned about stabilizing the helicopter, the student KNOWS they can no longer control it.
It's ironic this helicopter thing - the things which seem the most scary to a new student are usually the things which are actually the safest, and vice-versa.
Anyway, I don't let my students continue a failed experiment at any point - it's not about danger, it's about keeping the learning/experiential cycle focused on the desired outcome.
Using the hover again, you can let the student hold the helicopter within a 30' circle with big cyclic/collective movements, hoping that they will gradually use smaller and smaller movements (some do). Or you can focus on the subtle movements first, learning to hold a stable attitude without worrying about holding a specific position, knowing that when they master a light control touch, the position-keeping will be easy.