subject: Risk Management!! [print this page] Risk is nothing but a probability that something awful is likely to happen tomorrow in course of the action to be taken today. Likewise investment risk is the risk associated with putting money into the stock markets with a hope of earning returns but with more chances of leading oneself into losses.
Financial risk is the term used for all the risks associated with financing, viz; for credit: the risk of defaults, for Debt: the risk of bad debts, for investment: the risk of loss of principal and unpaid dividends, for trading: the risk of changes in the stock prices or the implied volatility, for liquidity: Assets cannot be sold or liabilities cannot be met quickly.
To overcome this risky situation of Hope for the best but be prepared for the worst, a unique concept of Risk Management has been developed as a precautionary measure. Risk management is to recognize, evaluate, and prioritize the risks followed by finding out alternative resources to monitor, control the probability of happening of the event. The alternative resources could be to avoid the risks, transfer it to somebody else, reduce the impact or accept it.
However, the situation with stock markets is a bit different! There is a misconception that higher the risks, higher are the returns. But the risk/return trade off tells us that higher risk is associated with either the higher returns or higher losses. Risk premium in equity markets is the expected return from a stock or a share minus the risk free return. The actual return is the dividend yield plus capital gains. So its up to the investor to decide whether he is satisfied with the risk free returns or willing to knock the other risky door which has 50-50 chances of either losing everything or gaining fabulous returns. The financial (equity) risk management strategies provide for the protection against decrease in stock value, generation of liquidity, diversification of portfolio and defer capital gains tax.
The best way is to initially judge yourself whether you have the potential of either bearing or overcoming the risks through virtual trading mechanisms before entering into the real stock markets. The stock market works on the sentiments of the mass investors and the greed, fear and hope as a part of the mass human psychology will eternally boost the risk taking abilities of the investors.
