Trading risk is a term that will crop up when you begin trading forex, stocks or commodities, It makes no difference which market you enter, but it is important to understand what trading risk means, how it will affect your decision making and how to monitor it effectively.
What does it mean? It is simply understanding that the investments you choose may not live up to your expectations. This could result in not getting the profits you were hoping for or losing the money you invested. In a worst-case scenario it could mean that you lose a higher amount than your original investment.
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Types of Trading Risk
The two main forms of trading risk are liquidity risk and market risk. In each style of trading, there are pitfalls to be aware of and avenues you can take to avoid the worst possible outcome. Because in short, you’re trading to make the highest profits you can safely expect while avoiding unpleasant or unexpected losses. Limit your loss by understanding the ins and outs of trading risk before jumping into a trade.
Liquidity Risk
While liquidity risk might not be the end of the world, it is a trading situation that you want to avoid. Liquidity risk is when you are forced into a situation where you must sell something at a lower price than you paid for it. For instance, if you want to sell off a stock or any asset and you can’t find a buyer, you may need to keep reducing the price significantly just to set yourself free from it. Here the point to consider isn’t whether you will gain or lose from this deal. It’s more about cutting your losses so that you don’t lose even more. You would want to get the best price that you can, take a financial hit and then keep going.
Market Risk
As all traders will tell you, the market is unpredictable. Even going into a trade with the best advice and current information, the market can turn unexpectedly. A sudden announcement in interest rates, a change in foreign exchange rates, movement in commodity prices or quick dips in the stock market can all affect your trade negatively. Since all of these movements were unexpected, it cannot always be possible to avoid losing money. As a trader, you will learn to take the good with the bad. Nothing is 100% predictable!
Assessing and Managing Risk
Going into any trade, we know that there is always a degree of risk involved. Some trades are more risky than others. That’s just the way it works. But if you spend time studying the markets and understanding the factors that might influence the various markets, you will have a leg up. As it happens, sometimes it’s the more risky investments that carry a higher potential for profit. If you understand that going into a trade, you should not be surprised if the deal goes south and you lose.
The key element in trading is to not risk more than you can afford to lose!
