If you have ever thought of trading or investing in the financial markets, the first thing in your mind must be online risk management. This basically means the process of understanding your risk tolerance, types of online risks you could be exposed to, and measuring risk versus return. This is the 4th point of the IDDA.
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Here are basics of online risk management you should know.
Online Risk Types
There are two types of online risk when it comes to trading and investing. Systematic and unsystematic.
Systematic risk represents the risk that is inherent in the “system” and cannot be eliminated through diversification.
Unsystematic risk represents the risk that can be diversified away, by combining multiple stocks, from multiple industries, into one portfolio.
Online Risk Management Process
The first thing you need to do in online risk management is calculating your risk tolerance. We will call this Step Zero.
This is not a one-size-fits-all thing. Each individual must calculate it personally before even thinking of joining the online markets. In this free workshop, Invest Diva gives you the basic tools to calculate your risk tolerance.
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Then, we need to take on the investment planning process for the type of investment that is suitable for our financial goals and is in line with our risk tolerance.
online risk management – investment planning process
The process includes these 4 steps.
Step #1: Create a written investment policy statement (with risk tolerance derived from the questionnaire you just filled out.) This will eventually help you build your own investment strategy.
This helps you create an investment policy to ensure realistic return goals consistent with acceptable risk, and enforce discipline in the investment process.
STEP 2: Examine the external environment focusing on expected short-term and medium term economic, legal, political, social and tax conditions.
STEP #3: Select an investment portfolio consistent with your investment policy statement.
STEP 4: Periodically monitor, update and evaluate your investment performance, together with your financial adviser.
You also have to be up to date with the external environment mentioned in step #2.
Online Risk vs. Return
Finally, you need to learn how to measure riskiness of assets, and calculate the expected rate of return.
- Expected return is a function of the riskiness of the investment(s).
- The more risk you are able and willing to accept, the more you can invest in stocks, ETFs or maybe even incredibly volatile assets such as forex.
Investment risk is broadly defined as the uncertainty surrounding returns, and it can be measured using Beta(β) or Standard Deviation (σ).
Online Risk Measurement: Beta(β)
Beta is used to measure the risk for a well diversified investment portfolio and systematic risk.
- The Market has a beta of 1.0.
- Beta greater than 1.0 is more volatile than the market.
- Beta of stocks –> finance.yahoo.com.
- Beta of Mutual Funds –> morningstar.com.
Online Risk Measurement: Standard Deviation (σ)
Standard Deviation is used to measure the total risk of any investment portfolio regardless of whether the portfolio is well diversified.
- The larger the standard deviation, the riskier the asset.
- It measures the amount of variation around a historical average.
- Low σ –> annual return is close to average.
- Large σ –> Large variation around average return.
If you are serious about investing, you need to be educated. You need to calculate your risk tolerance, develop an investment policy statement and create a portfolio suitable to YOUR need. Make sure you attend this free workshop to learn more about the steps you need to take in order to make your money work for you.
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