To manage something is to understand and control it. To manage the risk,
one must understand and control it. One will have a difficult time trying to
manage the risks that one does not understand. Once, one understands the
risk, one can now try to manage it. However, One can understand the risk,
but one may not be able to manage it. Here, the word manage means having
the ability, time and resources to contain what one is trying to manage.
Understanding
Risk And Risk Management
The
risk is the opposite goal (or reaction) to an initial goal (action).
Risk is
also the product of threat and vulnerability. Indeed if one is vulnerable and
faces a serious threat, one is under a high risk. A trader that is not well
equipped that enters a volatile or challenging market is a high risk taker. He
or she will be alright or come out unscathed if he or she manages to reduce
the risk. The lesser the risk or better one is equipped in the financial markets,
the more likely one will get something out of the markets. Generally, in trading
the goal is to make profit. The opposite goal is to make losses. For a technical
trader, the aim is to time the financial markets profitably, but the reaction to
that goal is not to time the markets accurately or profitably as one wants. For
a fundamental trader, the goal is to buy undervalued and promising financial
securities and sell them
profitably at a higher price.
The
opposing goal or reaction would be to buy distorted priced securities
(or overbought) at the wrong time, and being forced to sell them at loss.
Whether
one is an investor, trader or speculator, one must understand the
risk.
Even
if one is using the most sophisticated trading tool, one must carry
out a
full risk assessment before hitting the buy or sell button. Usually, less prudent
market participants get carried away, or let their guards down (when they think
that it is all well) just before they wipe out their trading account or investment
funds. It does not matter whether one is a day, swing, position trader or investor,
it is paramount to
be defensive, and apply a robust risk management.
For a day or swing trader, every trade involves a risk management or control. To
understand the risk, one must ask specific but relevant
questions.
1/
How much profit does the trade offer (ultimate profit and midpoint
profit)?
2/
How much does it cost to purchase or sell the financial
instrument?
3/
What is the maximum loss one can incur?
What
is the minimum loss one can accept (risk tolerance)?
4/
How volatile is the financial instrument?
5/
Is it a speculative trade?
6/
Which factors can increase the risk?
Those questions will help one to understand the risk, and be prepared to
implement a better risk management. Evidently, it is not sufficient to ask those
questions, but one wants to get the correct answers that will help to mitigate
the risk at hand. Once one has a clear understanding of the risk attached, the
next step is to control or manage the risk.
Managing
The Risk
To
manage
the risk one must answer the following questions:
1/
Which trading tool is best suited to control the risk? Use only those
tools.
Should
I buy and hold?
Should
I use put or call options?
Should
I use CFD or spread betting?
2/
What skills and experience are needed to control or
manage the
risk? Get
the skills and experience first before trading the financial asset. An incompetent
or amateur market participant will not manage the risk attached to the asset he
or she is trading.
3/
Has one got enough time to control the risk?
Time
is a valuable asset for a person that wants to control or
manage
the risk.
Therefore, if one does not have enough time, one is under pressure, it would be
prudent to stay out. Sometimes, one may have everything that is required to
control the risk except the time to implement the risk control. Time is a valuable
resource for a successful risks management in the financial markets whether one
is trading or investing.
3/
How to avoid the risk if possible?
Truly,
the best way to control other risks is to avoid them. Instead of
plunging
oneself into a risky trade or investment, one can just take cover or avoid it. Just
avoiding too risky investment is a wise thing
to do in many cases.
For
example a professional trader may avoid trading the first eight days
of the
month due to high
volatility in the markets.
4/
Which strategy will help to reduce the risk?
Reducing
the risk should be the first priority of all active financial market
participants.
Instead of aiming first for a maximum profit, one will avoid maximum losses if only
one aims to reduce the risk. Indeed, traders who do care about reducing the risk will
focus on high
probability trades. They will avoid useless investment.
They
will also avoid distorted price-action
that occurs
when the market environment
is too risky.
5/
How much resources are needed to manage
the risk?
One
needs enough resources (money, software, third party services)
to manage
the risk.
Sometimes,
one will be better off not taking part in any trade or investment
proposition
that one could not control due to a lack of adequate resources. For a trader, it may be just
one does not have enough money to support the trade or one does not want to set a bigger
stop-loss needed to protect the trade.
The subject of risk management is a big issue in the financial markets. Though, big financial
institutions such as hedge funds and investment banks do spend more time and resources to
mitigate the risks, most technical traders do not bother to do anything about the risk
management.
It is a shame that many financial market participants do lose just because they care less about
reducing the risk, and aim instead of maximizing the gains. Surely, the first objective should be
to reduce the risk. The goal to maximize profit should come second after the risk management
plan.
Truly,
one
will never come across a profitable trader or
investor that
does not aim first
to
manage
the risks. Those that get something out the financial markets are those that aim to put in place a
robust risk
management
at
every level.
Question
And Answers
1/
What is a risk?
2/
What are the questions that help one to understand the risk?
3/
what are the questions that help one to manage
the risk?
4/
Why time is an essential element for managing
risks in the financial markets.
5/
why is it important that one understands the risk before trying to
control or
manage
it.
6/
What trading or investing tools can one use to manage
the risks.
7/
What is a distorted priced asset?
8/
Why a distorted financial market is a risky one?
9/
Why the goal to maximize profit should be second to the goal to
reduce losses?
10/
Tell us a time when you
have
successfully managed risk in the financial markets.
11/
Tell us another time when you did not control the risks in the
financial markets.
12/
What is a risk-reward ratio?
13/
How to reduce risks?
Give
two examples.
14/
What risk tolerance?
15/
What is the advantage of using call or put options instead of spread
betting?
16/
what are the advantages and disadvantages of using CFD?
17/
What is a stop-loss?
18/
What are the advantages of using a limit order instead of market
order?
19/
How
technical traders use limit orders to reduce the risks?
20/
Risk is a likelihood of loss.
Yes or No?
21/
Threat is an outside force that can compromise your profit. Yes or
No.
22/
What is the difference between risk assessment and risk
management?
23/
What is risk mitigation?
24/
What is a due diligence?
25/
Why traders who trade very well still end up losing in the financial
markets?
26/
what is hedging?
27/
Give an example of how Forex trader could hedge EURUSD position?
28/
How traders use stop loss to reduce risks?
29/
Give two examples of risk in the financial markets when you would
rather avoid the risk altogether, and wait until market environment
becomes less riskier.
30/
Write down ten things that you could do to begin a
risk
management
in your trading or investing.
31/
What is the meaning of management
and control?
32/
To control something is to be able stop, reduce and
expand
it at will in any condition. Agree or disagree?