Risk management is associated with trading markets, but it is a concept that applies to all aspects of our lives, be it operating a machine or taking insurance to cover your health. Risk management is all about assessing and reacting to potential risks that may stand in the path of whatever you are undertaking. The interesting thing is most of the time, as a human being, you will manage these risks subconsciously as you undergo various activities. However, when it comes to financial markets and business administration, the practice of assessing risks is vital and very conscious.
In economics, risk management is described as the framework that defines how a company or investor handles financial risks that are part of business.
For people involved in the financial markets, such as traders and investors, the framework can include the management of multiple asset classes such as cryptocurrencies, commodities, forex, shares, real estate, and indices. This piece will focus on various financial risks that exist, and how they can be classified. It will also give an overview of the risk management process, and offer strategies that a trader or investor can employ to mitigate financial risks.
The Risk Management Process
There are five main steps involved in the risk management process. These include setting objectives, identifying risks, risk assessment, defining responses, and monitoring. These steps are not cast in stone and will change depending on the context. Let us take a look at each of them below.
This involves defining the main goals you are trying to achieve. It is related to the risk tolerance of an individual or company. You need to ask yourself how much risk you are willing to take to achieve your goals.
Then, you will move to detecting and defining the potential risks you are likely to encounter. This seeks to reveal all sorts of events that may lead to adverse consequences. This step can provide eye-opening information that is not related to financial risks in the business environment.
After you identify the risks, the next step is to evaluate their expected frequency and severity. These risks will then be ranked in order of importance, facilitating the creation or adoption of an appropriate response.
This is where you come up with a plan on how you will handle each risk you are likely to encounter according to their importance level. It establishes what action should be taken in the case of unfavorable events take place.
The last step when managing risk is to monitor its efficiency in response to events. Here you will constantly collect and analyse data. Managing Financial Risks.
There are many reasons why your trading strategy or trade setup can be unsuccessful. For example, you can lose money because the market moves against your futures contract position, or you get emotional and end up selling your assets out of panic. Emotional reactions will cause you to ignore or give up your initial strategy. This is most common during bear markets or when the market is excessively bleeding.
Most individuals involved in financial markets agree that having a proper risk management strategy does contribute drastically to their success. In practice, this can be as simple as setting a stop loss or take profit for orders.
A solid trading strategy should offer a clear set of possible actions. This allows the trader to be more than prepared to deal with all sorts of situations. The market is constantly evolving, and so should your strategies. They should be revised and adapted continuously.
Let us take a look at a few financial risks and how to mitigate against them Market Risk
This can be minimized by setting stop-loss orders on each trade to automatically close your positions before incurring bigger losses. Liquidity Risk
This can be managed by trading on high-volume markets. Typically, assets with a high market capitalization value tend to be more liquid. Credit Risk
This can be mitigated by trading through a trustworthy exchange so that borrowers and lenders or buyers and sellers do not have to trust each other. Operational Risk
As an investor, you can mitigate operational risks by diversifying your portfolio, which prevents you from exposure to a single project or company. You can also do some research and identify projects that are less likely to experience operational malfunctions.
This can be mitigated by diversifying your portfolio by investing in projects handling different issues or companies based in different industries.
Before you open a trading position or allocate capital to a portfolio, you should develop a risk management strategy. Also, you need to be aware that financial risks can’t be avoided entirely. Even though risk management defines how to handle risks, it is not only about mitigating risks. It also offers strategic thinking to take the unavoidable risks in the most efficient way possible.
Disclaimer: The content in this report is from the open source and for educational purposes only, therefore should not be considered as financial advice. We all know that the cryptocurrency market is highly volatile. Therefore, all the financial decisions should be made after doing your wide spectrum research.