content

  • What is risk management?

  • How Risk Management Works

    • set a goal

    • Identify risks

    • risk assessment

    • risk control

    • risk monitoring

  • Manage financial risk

  • Summarize


What is risk management?

We manage risk throughout our lives, whether in our daily lives (like driving a car) or when setting up a new insurance or medical plan. Risk management is related to the assessment and control of risks.

Most people manage risk unconsciously on a daily basis. But when it comes to financial markets and business operations, assessing risk becomes a very important and prudent practice.

At the financial level, we will use a framework for how companies or investors handle financial risks to describe existing risk management measures in various industries.

For traders and investors, this framework may include the management of a variety of assets such as cryptocurrencies, forex trading, commodities, stocks, indices and real estate.

Many different types of financial risks can be classified in different ways. This article provides only an overview of the risk management process. It also provides risk management strategies to help traders and investors mitigate financial risks.


How risk management works

Generally speaking, the risk management process consists of five steps: setting goals, identifying risks, risk assessment, risk control, and risk monitoring. However, these types of steps can vary greatly for different situations.

set a goal

The first step is to define the main goals. Often related to the risk tolerance of a company or individual. In other words, how much risk they can take to achieve their goals.

Identify risks

The second step involves detecting and defining potential risks. This step aims to identify various risk events that could lead to negative impacts. In commercial activities, this step can also identify other information not directly related to financial risk.

risk assessment

Once a risk has been identified, the next step is to assess its probability of occurrence and severity. The risks are then ranked in order of importance, which helps create or take appropriate risk controls.

risk control

The fourth step is to define corresponding control measures for each risk according to the importance level of the risk. It determines the measures to be taken when a risk event occurs.

Risk Monitoring

The final step in a risk management strategy is to monitor the effectiveness of risk controls. This often requires continuous collection and analysis of relevant data.


financial risk management

In a financial trading scenario, there are many reasons why a strategy or trading setup can become risky. For example, traders may suffer losses when the market reneges on their futures contract positions or becomes emotional, ultimately causing panic and selling assets.

Emotions often cause traders to ignore or abandon their original strategies. This is especially true during bear markets and market downturns.

In the financial markets, most people agree that having a proper risk management strategy can greatly contribute to trading success. In fact, risk management can be as simple as placing a stop-loss or take-profit order.

A robust trading strategy should provide clear and controllable risk management measures, which means traders can be more prepared to deal with various unexpected situations. As mentioned before, though there are many ways to manage risk. Ideally, risk management strategies should be continually modified and adjusted based on actual circumstances.

Below are some examples of financial risk management and a brief overview of how to mitigate risk.

  • Market risk: It can be minimized by placing a stop-loss order on every trade, which automatically closes the position before significant losses are incurred.

  • Liquidity risk: This risk can be mitigated by trading in mainstream markets. Generally, assets with high market capitalizations tend to be more liquid.

  • Credit Risk: Credit risk can be reduced by conducting transactions through trusted exchanges, so that borrowers and lenders (or buyers and sellers) do not need to trust each other.

  • Operational risk: Investors can mitigate operational risk by diversifying their portfolio and not putting their eggs in one cage, preventing investment in a single project or company. To avoid operational risks, investors usually conduct some research and look for companies with lower operational risks.

  • Systemic risk: can also be reduced through portfolio diversification. But more often than not, diversified investments should at least be companies from different industries or clearly differentiated projects. It is best for projects to be invested in that exhibit very low correlations.


Summarize

Before opening a trading position or allocating funds to a portfolio, traders and investors should consider developing a risk management strategy. However, it is important to remember that financial risks cannot be completely avoided.

Overall, risk management defines how risks are handled, not just how they are mitigated. There should also be strategic thinking in order to mitigate unavoidable risks in the most effective way.

In other words, risk management should include risk identification, risk assessment and risk monitoring. The risk management process aims to evaluate the risk/reward ratio so that investors can find the most profitable position transactions.