Defining Risk. A concept, a term that is frequently thrown around the financial trading community. A term that is widely used, wildly misunderstood and narrowly implemented. So, what is it then? Is it really that important? Why do I care about it?
What is it?
Risk, according to Merrian-Webster is ‘the possibility that something bad or unpleasant (such as an injury or a loss) will happen’.
Knowing this, we can now begin to derive the meaning of the term ‘Defining Risk’. If Risk is the possibility of something bad happening, then defining risk is the actual numeric value for ‘something bad happening’, which otherwise, is an arbitrary number.
Great. We now have a concrete definition for this elusive term.
Is it really that important though?
Of course it is. Without the definition of risk within our trades, we suffer the possibility of unknowingly putting on too much risk relative to our emotional, physiological, and monetary capital. The problem many investors face when basing their decisions off of fundamental analysis or sales forecasts is the inability (or at least more difficult) to set a place, a numeric number in which ‘they’.
Ok, cool. Now we know what it is and that it truly is important to be able to define risk. But….
Should I really care?
It is vital to implement a sound risk management process for long-term success in the stock market. This is because as market participants it is important to keep emotional, physiological and monetary capital at reasonable levels relative to our desired risk. The only way this is numerically possible is to implement a strategy in which your analysis is hinged on numeric values alone, thus the study of price action (technical analysis) is our best.