In the financial world, risk management is the process of identification, analysis, and acceptance or reasoning of uncertainty in investment decisions. Essentially, risk management occurs when an investor or fund manager analyzes and attempts to calculate the potential for losses in an investment. Losses such as a moral hazard, and then take the appropriate action or no action given the fund’s investment objectives and risk tolerance. Risk is inseparable from return in the investment world. Every investment involves some degree of risk, which is considered close to zero in the case of a U.S. T-bill.
Or very high for something such as emerging-market equities or real estate in highly inflationary markets. Risk is quantifiable both in absolute and relative terms. A solid understanding of risk in its different forms can help investors to better understand the opportunities, trade-offs, and costs involved with different investment approaches. Risk management occurs everywhere in the realm of finance. Inadequate risk management can result in severe penalties for companies, individuals, and the economy.
Risk Management: Dealing With Risk
Risk management occurs when an investor buys U.S. Treasury bonds over corporate bonds. Also, when a fund manager hedges his currency exposure with currency derivatives. This is also seen when a bank performs a credit check on an individual before issuing a personal line of credit. Stockbrokers use financial instruments like options and futures. Money managers use strategies like portfolio diversification, asset allocation, and position sizing to mitigate or effectively manage risk. We lean towards thinking of “risk” in mainly bad terms.
However, the risk is necessary in the investment world and attached to wanted performance. A common definition of investment risk is a deviation from an expected outcome. While that deviation may be positive or negative, investment professionals generally accept the idea that such deviation implies some degree of the intended outcome for your investments. Therefore, to achieve higher returns, one expects to accept the greater risk. It is also a generally known idea that larger risk comes in the form of bigger volatility.
While investment professionals continuously look for and rarely find ways to reduce such volatility. There is no clear agreement among them on how it’s best done. How much volatility an investor should take depends completely on the individual investor’s tolerance for risk. Or how much tolerance their investment objectives allow. One of the most frequently used complete risk metrics is the standard deviation.
You look at the average return of an investment and then find its average standard deviation over the same period. Normal distributions are typically known as the familiar bell-shaped curve. Show that the expected return of the investment is likely to be one standard deviation from the average 67% of the time and two standard deviations from the average deviation 95% of the time. This helps investors evaluate risk numerically. If they believe that they can accept the financial and emotional risk, they invest.
While a bell-shaped curve may be helpful, it does not address an investor’s risk concerns fully. The field of behavioral finance has contributed an important element to the risk equation. Behavioral finance is an area of study focused on how psychological influences can affect market outcomes. Behavioral finance can be analyzed to understand different outcomes across a variety of sectors and industries. Some common behavioral financial aspects include loss aversion, consensus bias, and familiarity tendencies.
Behavioral Finance
When it comes to behavioral finance, it is said that partakers are not rational and are influenced psychologically. Financial decision-making often relies on the investor’s mental and physical health. As an investor’s overall health improves, their mental state often changes. This impacts their decision-making and levelheadedness towards all real-world problems; including those specific to finance. One of the key aspects of behavioral finance studies is the influence of biases. Biases can occur for several reasons and can be classified into one of five key concepts. Understanding and classifying different types of behavioral finance biases can be very important when narrowing in on the study or analysis of industry or sector outcomes and results.
Behavioral finance typically covers five main concepts. Mental accounting refers to the tendency of people to distribute money for detailed purposes. Herd behavior is the belief that people tend to copy the financial behaviors of the majority of the herd. An emotional gap is decision-making based on extreme emotions such as anxiety, anger, fear, or excitement. These are key reasons why people do not make balanced choices. Anchoring refers to attaching a spending level to a certain situation. Self-attribution refers to a tendency to make choices based on overconfidence in one’s own knowledge or skill.
All of these concepts are seen in day trading. Investors hold onto investments longer than they should. They also sell too early or lose positions and then revenge trade in the hope to break even. Not thinking of the financial risk, just letting their emotions take the wheel. Risk reduction measures and risk management decisions can make or break your capital when day trading.
Trading Risk Management
Risk management is an important but often disregarded condition to successful active trading. Managing your risk cuts down losses and helps protect traders from losing all of their money. When risks are managed correctly, they make profits in the market. Emotions are quick to take over traders when they enter a trade not having an idea of which they will sell; at either a profit or a loss. A proper risk-management strategy is necessary to figure out your win-loss ratio. Risk identification and minimizing losses is often the most important part of any strategy.
Trading is risky, that is how it offers a high potential reward. It is impossible to win every trade, so it is important to keep those trades that are lost under control by managing risks. This can be done by limiting your trade size and setting stop losses. Trading with money that wouldn’t hurt you substantially if lost. Only you know what that number is, as you know your finances best. Do a complete risk assessment on yourself and identify risks to increase positive events and decrease negative events.
Summary: Risk Management
You learned the ins and outs of risk management and how it is connected with day trading. Warren Buffett said, “risk comes from not knowing what you’re doing”. You need to make sure you have the right mentor to teach you how to manage risks instead of letting them control you. I can teach you how to day trade like the top 10% without a complicated strategy or any technical indicators, even if you are a beginner. My goal has always been to teach as many day traders to achieve their personal financial goals, whether they are novice traders or experienced traders.
The MK VIP training has plenty of resources to help you get started on reaching your day trading goals and teach you about market risk. I teach the working class how to earn $10,000 a month through day trading. I help my students avoid the challenges I faced when I first became a day trader. As of now, MK Financial LLC is already the #1-day trading coaching business in the US in just one year. You are just a click away from learning how you reduce risk as a day trader with any amount of capital and take your life and salary to the next level.
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