The 5 Most Important Things that You Need to Know About Risk Management

Managing risks is a process of identifying potential problems and reducing their likelihood and/or impact. I think it’s important to know the difference between risks and uncertainty. 

Uncertainty is something that we cannot predict, while a risk is something with a possibility of happening. Different people have different risk tolerances. I like to think of risk as a percentage of the chance that something will happen. 

There are a lot of resources out there on risk management. I often find, though, that even the best-intentioned blog posts and articles on the subject are too long to read in one sitting. Plus they’re often written from the perspective of someone who knows a lot about the subject. 

That’s why I decided to create a list of the five most important things you need to know about risk management. I’ll be writing about these topics a lot more in the future, but this list is a great overview of the most essential information.

Here are the five most important things you need to know about risk management.

1. What is risk management?

The simplest way to describe risk management is to use the example of putting a long trade on and starting to go long. What are your initial and your end points? Is there any wiggle room? You should not risk more than what you are willing to lose. How can you measure your risk? How can you make decisions to control your risk? The term risk is widely used when referring to financial markets. The most common interpretation of risk relates to extreme returns. If you have large losses then you will earn large returns. If you have large gains then you will lose a lot of money. This is not the only way to look at risk. You can also look at risk from an extreme return perspective.

2. Why is risk management important?

If you run an FX desk, for example, you will need to manage your risk on trades, not just add a little bit of capital and “set it and forget it”. While that’s possible, in fact, it’s almost guaranteed to result in losses. Risk management must be something that is done on a continuous basis. Knowing what you want to achieve with a trade and also knowing what to look out for is critical. It also has to be an ongoing process. As we can see, this topic is crucial to becoming a trader of value. If you’re not risk averse you’ll probably end up with all of your money in CDS, which is a whole different world of pain and suffering. I have put together five important things that you must know about risk management and its importance in a trading environment.

3. What are the risks of risk management?

If you want to get up to speed on risk management, I recommend reading a piece by Dan Amoss. Dan’s approach is useful: Read a book. I really love this simple but fundamental idea. Read a book. What does a book teach you? Something about the nature of human behavior? You learn a lot about human behavior from reading a book. As simple as it is, it has saved me from some very bad trades. Read some blogs. Nothing beats reading blogs from people who you think have something worthwhile to say. If you can read something intelligent that’s fun to read, that’s a pretty good way to ensure that you have more solid rules of thumb about how to deal with risk. I’m a big fan of Ed Thorp’s blog. Go through a few model portfolios.

4. What are the benefits of risk management?

For all the firsts. The first time you think of buying a stock. The first time you sold a stock. The first time you lost money in a trade. The first time you didn’t pay attention to your risk management. The first time you did a trade without properly understanding your limits. The first time you did a trade only because it looked like a winner! The first time you changed your mind while reading a book. The first time you read a book with your brokerage account open. The first time you forgot to cancel your order. The first time you forgot to close your account. For all the seconds. The second time you bought a stock. The second time you sold a stock. The second time you lost money in a trade. The second time you failed to track your limits. The second time you forgot to cancel an order.

5. How do I manage risk?

Are there risks that aren’t even mentioned? How do you know what you don’t know? Today, I’ll share 5 steps that will give you a clear understanding of what risk management is, and how to use it for managing your own trading. I’ll also cover a few strategies I’ve used that have worked well. But first, let’s look at the basics. 1. What is Risk Management? When people think of risk management, they often think of insurance. But really, it can be more than just buying insurance. It’s the most important tool for improving the odds of a successful trading strategy. It should be taken on a daily basis, with constant review and analysis. What is Risk Management? I learned about risk management from a course in the Risk Management Institute in NYC.

Conclusion

Like I said in the beginning, these days everyone should learn to trade regardless of whether they are a pro or not. It takes a special breed to work as a professional trader, and anyone can become one with the right amount of practice, effort, and discipline. For more about how I’ve become a trader, check out my eBook on the subject “Trading For Free”.