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Understanding Risks In Trading

Normally, experts talk about two types of risks in a trade: the risk in the stop and the risk in the size of the position (or the total risk of its portfolio). However, the reality is that there are many other types of risks. Risks in an operation, especially in the current market circumstances. Below is a list of the most common risks traders face:

  • Default risk in a trading
  • Risk in the size of a position (the total risk determined by the trade and the size of the position)
  • Market risk
  • Risk of the company with which we are investing
  • Psychological risk

Many operators even the most experienced had no idea that there were so many risks to the market in this difficult climate in which it has been for months. Below we will go a little deeper into the aforementioned risks:

Default Risk

Anyone with a little notion about trading knows that you should not enter into an operation without first knowing the potential risk of it and without having placed a stop loss as a form of protection. For example, a good substitute for the practice of buying and holding in the stock market is the use of a trailing stop of 25%. In this case the initial risk is 25% of the entry price. The trader will be wrong about a trade if the price falls below that level, so he will immediately have to go out and take his losses. With a trailing stop, each time the market moves in the desired direction and makes a high or a low,

Risk in position size

It is the total risk associated when the operator multiplies the number of shares / currencies / commodities that it acquires when making a trade. Whatever the transaction, it is not recommended to risk more than 1% of the capital used to invest.

Market risk

Currently the financial markets are really big and the small operators all we have left is to always try to go with the flow. If the market goes down or rises we should try to go with it. However there is always the risk that the market will turn against us and what promises to be a winning trade becomes one that only brings us losses. To mitigate the effects of this risk we must always control the size of our positions.

Risk of the company with which we are investing

The reality is that there is always a risk that the company where we have our investment will fail and fall. For example what happens when the company that holds a whole group of ETF suddenly falls, as happened with Lehman Brothers. Or what if the company behind your mutual funds falls or if the same happens to your Hedge Funds. Or if it happens the same as in the famous Madox case in which those companies eventually turn out to be a Ponzi scheme. These forms of risk are quite real in the current times. So the wisest thing to ask yourself is: What could possibly fail to turn these investments into a total loss or keep me tied to the courts for a long time?

Psychological risk

This is probably the biggest risk of all because many times the worst enemy is the same trader. A good trader can have an efficiency of 90%, which means that he can make a mistake in one of every ten trades, where that error is simply because he did not follow the rules of his trading system. This is probably the biggest risk you can face at any time when you operate in the market. Also the trader who does not have a guide to written rules to operate, the truth is that he is doing everything wrong from the beginning.

Typically, people open their positions ignoring the potential risks they are taking. However if you study and understand these risks, you will be able to minimize them.