EXPECT THE UNEXPECTED
There is a world of risk out there, and managing it is a lifetime endeavor. Every time you get in the car, you risk the possibility of having an automobile accident. When you walk in a thunderstorm, you risk getting hit by lightning (a remote risk, but a risk nonetheless). You may face certain medical risks (which vary, depending on genetic and family history) or risk of losing your job—the list can go on and on.
Typically, in our society, we attempt to control or manage these risks by obtaining insurance, or by using greater care in our day-to-day behavior and choices. For example, you may very well currently have an insurance policy that protects you from auto theft, collision, and bodily injury. You might have medical, life, homeowners, or unemployment insurance. And if you are really responsible, you probably exercise, eat right, and look both ways before you cross the street. All these precautions and procedures are designed to reduce, not eliminate, the possibility of being devastated by a variety of unexpected circumstances. And that is just the point: These circumstances are unexpected.
Our job as traders is to make a habit of expecting and being prepared for the unexpected. In addition, we need to avoid a state of “trader paralysis” that can be created by unexpected events. If we are well prepared we are better equipped to combat the fear that trading can trigger.
SIX TYPES OF RISK TO MANAGE IN TRADING
In the spirit of expecting the unexpected, we can always attempt to plan for what might happen. In doing so, there are half a dozen primary types of risk for you to consider every time you place a trade. We will cover each of these in detail in the coming posts, but ponder the following top six for now:
1. Trade risk
2. Market risk
3. Margin risk
4. Liquidity risk
5. Overnight risk
6. Volatility risk
(Excerpts from A Trader′s Money Management System: How to Ensure Profit and Avoid the Risk of Ruin (Wiley Trading, 2008) by Steve Nison and Bennett A. McDowell)