Manage
the risk in trading
The
first and most important thing to realize about risk management
is that there is no such thing as no-risk investment. Before
you even get to worrying about the technical and financial
aspects of being a trader, you need to understand the outside
forces that are working against you. We call them "outside"
forces because they operate outside of the market. In reality,
they are inside forces because they come from within you.
This
is a fundamental characteristic of the nature of financial
institutions; the risk is the offset to the possibility
of profit. If there were any certain investments,
everyone would invest in those and the market would fail.
I will give a brief outline of a few of the different types
of risks to what you might otherwise consider secure investments.
Let's say inflation rises after you purchase your 5-year
GIC; this often causes interest rates to rise as well. What
happens if you find that in your third year, interest rates
have risen to 12 or 13%? You are stuck in your five-year
contract at 11%, with a loss. Another risk to consider is
the inevitable tax risk, of which every investor should
be aware. GICs, to continue with the previous example, are
notorious for being heavily taxed. Sale risk is often forgotten
during the heat of daily trading, but is no less important
than any of the other types of risks. It refers to the risk
of not being able to sell an asset at the quoted price,
and can arise due to any number of reasons. The only way
to minimize this type of risk is to know what you are buying
and to ensure that there is a market to sell. It's not wise
to manage your investments solely by the numbers.
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