We manage the risks of life all the time, whether it's while performing simple tasks (such as driving a car), taking out insurance or planning medical treatment. In essence, risk management is a story about assessing and responding to risk.
What is risk management?
In economics, we can describe risk management as a system of rules governing how a company or investor handles the financial risks inherent in all types of businesses.
For traders and investors, this system can include the management of several asset classes, such as cryptocurrencies, Forex, commodities, stocks, indices and real estate.
There are many types of financial risks that can be classified in different ways. This article provides an overview of the risk management process. It also presents some strategies that can help traders and investors reduce these risks.
How does risk management work?
Risk management typically involves five steps: identifying risk targets, defining risks, assessing risks, defining strategies, and monitoring. Depending on the context, the steps can vary significantly.
Defining risk objects
The first step is to identify the main objectives. These are often related to a company's or individual's attitude toward risk. In other words, what risks they are willing to take to achieve their goals.
Identify Risks
The second step is to identify and define potential risks. The goal is to list all of the events that could cause negative impacts. In business, this step may also include an in-depth analysis not directly related to financial risks.
Risk Assessment
The next step after identifying risks is assessing their potential frequency and severity. Risks are ranked in order of importance, thereby conditioning the development and implementation of appropriate responses.
Defining the strategy
The fourth step is to determine the response to each type of risk according to its level of importance. In this step, the measures to be taken in case a risk materializes are defined.
Monitoring
The fifth step of the risk management strategy is to monitor the effectiveness of the response to events. Often, continuous data collection and analysis is required.
Financial Risk Management
There are several reasons why a trading strategy or setup can be unsuccessful. For example, a trader may lose money because the market moves against a futures contract position or because players are exposed to emotions and sell assets due to panic.
Emotional reactions often cause traders to deviate from their original strategy. This is especially noticeable during bear market periods and periods of capitulation.
Most financial market participants agree that having a proper risk management strategy contributes significantly to their success. In practice, it can be as simple as setting Stop-Loss or Take-Profit orders.
A solid trading strategy should provide a clear pool of possible moves, meaning that the trader will be more prepared for all possible situations. As mentioned, there are many ways to manage risk. Ideally, the strategy should be continually reviewed and adapted to market conditions.
Below are a few examples of financial risks as well as a brief description of how to mitigate them.
- Market Risk: Can be minimized by creating a Stop-Loss order on every trade so that positions are automatically closed before heavy losses are incurred.
- Liquidity Risk: Can be mitigated by trading in markets with high activity. Assets with high market capitalization tend to have greater liquidity.
- Credit Risk: Can be mitigated by trading on trusted exchanges so that borrowers and lenders (or buyers and sellers) do not have to check directly with each other for good faith.
- Operational Risk: Investors can reduce operational risk by diversifying their portfolio, thereby reducing the negative impact of a project or company. They can also perform market analysis to find companies that are less prone to disruption.
- Systemic risk: Can also be reduced by portfolio diversification. But in this case, diversification should include projects with different products or companies from different fields. Those with very low correlation are preferred.
A few cryptocurrency risk management tips:
- Have a personal trading strategy and know your systemic entry points.
- Trade with an amount you are comfortable with. Don't trade on borrowed and last funds.
- Take a break from the market. Take a break from the market, both when you have a series of profitable trades and when you have losses.
- Trade only by the trend.
- Not be guided by emotions. Not to fall into excitement. Do not think you are almighty.
Conclusion
Before opening a trading position or allocating capital to a portfolio, traders and investors should consider a risk management strategy. At the same time, it must be understood that financial risks cannot be completely eliminated.
Risk management is not just about how to reduce risk. It also involves thinking strategically so that unavoidable risks can be managed in the most effective way possible.
In other words, risk management is about identifying, assessing and monitoring risks according to context and strategy. The purpose of risk management is to assess the risk-benefit ratio to determine the most profitable positions.
Keep your nose to the wind and know that Fortune, Luck and Success
always favor you,
when you are with us!
Always yours C.J.
All the above is not financial advice, but only a subjective opinion of the author. If you doubt something, do your own research and double-check the information yourself.
