RISK MANAGEMENT

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Business

Risk Management helps protect a business from losing a substantial amount of money in highly volatile market conditions. In one way or the other, each one of us have at some point applied risk management techniques to protect our financial interests. It can be a simple medical insurance policy to ensure that financial crisis doesn't arise due to huge hospital bills. Similarly in business, especially with commodities that are highly volatile due to various factors may cause immense financial burden due to the rise and fall of the markets. For instance a business house stocks up huge inventories in anticipation of future sales and finds that the prices have come crashing down will result in huge losses, they can protect their losses by hedging their open positions in the futures market. Counter positions in futures are taken with the same commodity or the commodity that inherits similar price trends.

Investing

One way to manage risk in trading securities is to use stop loss orders, trailing stops, or a mechanical system like Wells Wilder's Parabolic, to take you out when the trend changes. [1]

A prudent investor diversifies their holdings in a diversified portfolio of assets, to reduce the risk of having to liquidate when they are all experancing drawdowns. Spreading out your purchases over the whole business cycle will reduce the risk of putting too much on at the wrong place in the cycle. Risk can also be addressed in the size of your position relative to the size of your total portfolio, and the spread of your diversification among uncorrelated assets. [2]

Risk is reduced by spreading the total investment money available across different asset classes, countries, industries, and individual companies. You must also be sure that they are, as far as possible, uncorrelated. Which means that when investment A is performing poorly, investment B is likely to be performing well. [3]

From 1660s risque, "run into danger," of uncertain origin. Risk management from 1963. [1]

References

  1. New Concepts in Technical Trading Systems J. Welles Wilder ISBN-10: 0894590278
  2. Trade Your Way to Financial Freedom Van Tharp ISBN-10: 007147871X
  3. Mutual Funds: An Introduction to the Core Concepts by Dr. Mark Mobius ISBN-10: 0470821434 Chapter 4
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