Understanding Trading Risk

Investment always involves a certain level of trading risk. And as a beginner trader, before you enter the markets, it’s essential to understand risk and how inherent to trading it is.

What is Risk in Trading?

Risk in trading can be defined as market uncertainty and/or volatility. Market volatility can create higher returns but equally higher losses. In this sense, investment is a double-edged sword. 

Risk tolerance is different from person to person. Before you start to trade, you should first understand your tolerance and what trading risk you can bear. Indeed, recognizing risks too late can lead to a series of bad decisions once you get into the market. These, in turn, can then affect your investment mindset, leading to heavy losses.

The key is to find the balance between taking risks and not taking any. The return on investment is proportional to the risk. It is unrealistic to say that we want low risk and high return. But on the contrary, it is also unrealistic not to invest because of risks.

In Trading, Risk Is Unavoidable

Before you enter the financial markets, you should know there is no risk-free trading. There are two types of risk in financial markets: unsystematic and systematic.

  • Unsystematic risk comes from the investment target itself. Portfolio diversification can reduce, though not eliminate, this type of risk.
  • Systematic risk, on the other hand, cannot be dispersed. It is an uncontrollable market risk related to politics, economic cycles and natural disasters.

All assets carry risk, even US Treasury bonds or bank deposits, which many consider very safe. There is always the possibility of loss, as government or financial institutions can still collapse.

Compared to other risks, this situation is doubtful, but the trading risk remains. There is no such thing as zero risk when you trade. The best way to avoid it is to practice, gain experience and keep learning about the financial markets.

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