You probably have the same issue as almost everyone else. We were all taught that risk is bad. Which leads most people to let their losses run and then they cut their profits short.
And that stops almost everyone in their tracks when it comes to investing.
A Brief Look At Risk
People take risks every day, even driving to work constitutes a risk, since nearly 1.3 million people die in road crashes each year across the globe.
Staying at home with your head stuck under the covers, however, is just as big a risk. Because if you do that you are going to be 100X more likely to suffer from anxiety and depression.
Which can lead to suicide.
No matter what we do, we will be taking a risk. The secret of taking risk successfully is to be prepared. This requires a person to know the kind of risk involved.
Understanding the risk can be difficult because the topic has so many dimensions.
Investment risk is defined objectively as the variability of performance of invested funds that go up and down in value. Now if you add to that, that each investor has a subjective concept of risk which may have little relation to the performance variability.
You start to understand that subjective risk has more to do with the fear that a person attaches to a particular activity, rather than the activity itself.
Jumping Into The Fire
Let’s take career choices as an example. Who would you say takes the bigger risk a Helicopter pilot who takes holiday makers across a lava lake on Hawaii or… a schoolteacher?
No brainer, right?… The schoolteacher. Ha ha only kidding it’s obviously the helicopter pilot.
Or is it?
What if I told you that the schoolteacher works in a high school in Los Angeles with the highest number of gang-related incidents happening every day in school.
That’s incidents every day.
Also, she has to commute 25 miles on Los Angeles freeways during rush hour. How about if I added the facts that she has been involved in two fender benders in the last five years.
And get’s her life threatened on a regular basis, while the helicopter pilot has had no incidents in the last 15 years.
Now, who do you believe is taking the bigger risk every day?
Let’s say we have two investors, one invests in Forex, and the other buys and holds gold. Who takes the bigger risk?
What if I told you that the Forex investor’s trader only risks 2% per trade with a maximum of six trades open at any one time, while the gold trader is fully invested at all times…
Which means that she always has all her capital tied up in gold.
Now, who would you say is the bigger risk taker?
Did you change your mind?
People assume, for example, that Forex Investing is risky because most Forex traders lose, whereas investing in gold is less risky because fewer people lose.
Obviously, the second part of that statement is debatable – gold investors may just take longer to lose.
The probability of losing in an investment instrument is just a subjective definition of risk… i.e., people tend to think that if most people lose, that instrument must be risky.
A Definition Of Risk
The objective version of risk in contrast, is how much you stand to lose on a given position. And a prop trader (money manager) might take low-risk ideas say 1% per trade and regularly make 6-10% per month.
If the prop traders’ performance is consistently good, then he takes little risk from the objective viewpoint.
Whereas most traders will not search for low-risk ideas. Their performance will be erratic at best, and as a result, their account variability (the risk) will be high.
In order to invest, you must know that your prop trader (money manager/financial advisor) knows how to find low-risk ideas and implements them consistently… keeping your risk low.
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