Proper risk management strategies are essential and they play a vital role for all traders in the market. However, it is often overlooked as a prerequisite to a successful trading transaction.
Making strategies for risk can involve more than just deciding whether to accept the risk or not. It can be either beneficial or detrimental. For example, if proper risk management isn’t employed or strategized without proper knowledge, a trader who earned substantial profits over his or her career can lose it all in just a snap.
This educational article of BWorld Reviews will give you some tips on proper risk management strategies for traders and companies in the market. Continue reading in order for you to apply these steps that would definitely help you in the future!
Breaking Down ‘Risk’
Risk management is the process of identifying, assessing, and controlling threats or ‘risks’ to a company or organization’s capital and earnings. Risks can be formed from a variety of factors, such opportunity-based, uncertainty-based, and hazard-based risks. This means that it covers a lot of ground for you if you do the management properly.
Opportunity-based risks come from taking a specific opportunity over another. As a result, you risk missing a better opportunity and getting unexpected results. Some examples of opportunity-based risks for a business are moving a business to a different location, buying a new property, or selling a new product or service.
On the other hand, uncertainty-based risks come from unexpected events. These include natural disasters, court action, financial loss due to economic crisis, and decrease in market share.
Meanwhile, Hazard-based risks come from dangerous situations in the workplace. Examples of hazard-based risks are equipment, chemical, psychological, and biological hazards.
Every company has their own and distinct risk management strategies and plans in order for these threats to be controlled properly. With proper risk management, companies can protect their assets from a chance of negative impact and collateral damage to a business.
Planning Every Trades
It is impossible to achieve something or make a work done without proper planning. It is necessary to keep good control, and it helps to achieve objectives.
Planning is preparing a sequence of action steps to achieve some specific goal. If a person does it effectively, they can reduce much the necessary time and effort of achieving the goal.
Stop-loss (S/L) and take-profit (T-P) points represent two key ways in which traders can plan ahead when trading.
A stop-loss point is the price at which a trader will sell a stock and take a loss on the trade. Most of the time, it happens when a trade does not pan out the way a trade hoped. On the other hand, the take-profit point is the price at which a trader will sell a stock and take a profit on the table.
In order to become a successful trader, you must know what price you are willing to pay and what price you are willing to sell. You must also measure the resulting returns against the probability of the stock hitting your goals. You can execute a trade if the adjusted return is high enough for you.
Calculate Expected Return
Expected return is derived from the formula: [(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop Loss % Loss)].
An effective use of S/L and T/P would minimize not only your losses, but also the number of times a specific trade is exited needlessly.
There are three steps to consider on making a good risk management strategy to a business:
Identify the Risk
The first step is to identify possible risks.
A thorough research is needed for searching past events or risks happened in your company and other companies similar to yours.
Identifying possible future changes to a business environment, such as market movement, and changes in economic trends, is also needed.
Never underestimate the social and community issues, as it is proven to make a huge impact to a business.
To identify risks, you can search and look at hazard logs, incident reports, feedbacks, complaints, and survey reports, checklists, assumption analysis, and diagrams.
Reviewing audit reports, such as financial audit reports or workplace safety reports is also a good risk identifier.
A strength, weaknesses, opportunities, and threats (SWOT) analysis would play a huge role on every company. It is a useful technique for understanding a certain company’s strength and weakness, and for identifying possible opportunities and threats it might face.
Discussing issues face-to-face with staff, customers, suppliers, and advisors is also a good technique.
After identifying the risks, the next step is to work out which ones are urgent. In order to categorize which risks would make a huge impact to the company, you should look at:
- The damage that the risk would cause. An example is the risk of fewer customers means lower sales for a business;
- The likelihood of the risk. For example, think about how similar the competitor’s business is to yours, and the loyalty of the customers
Having a rating system from 1 (least damage) to 4 (most damage) would be helpful. To work out the level of risk for an event, use the formula: Risk level = damage x likelihood.
With the formula above, the lowest risk you could get is 1 (1×1) and the highest risk is 16 (4×4).
In order to evaluate a risk, you should compare the risk level for events against your risk criteria using risk management plan.
Also, you should also check if the existing risk management methods are enough to accept the risk.
Companies choose to accept risks and not spend any resources on avoiding them. The following reasons below might help you decide the level of risk:
- The cost of treatment is higher than the risk’s potential results;
- The risk level works out to be very low;
- The benefits of taking the risk greatly outweigh the possible damage.
Strategic Risk Management
Strategic Risk Management is a process of identifying, quantifying, and mitigating any risk that affects or is inherent in a business strategy objectives or execution.
It includes shifts in consumer demand and preferences, competitive pressure, technological changes, and stakeholder pressure.
Measuring Strategic Risk
Strategic risk falls along a classic bell curve, as the results along the x-axis and likelihood along the y-axis.
The expected result of a given strategy would represent the peak of the curve. Most strategic planning considers only this peak while ignoring the slopes on both sides.
A narrow steep on the curve indicates a low risk of failure and little upside opportunity. The wider bell, on the other hand, indicates greater chances of both under and over performance.
Managing Strategic Risk
- Defining strategy and objectives.
- Establishing key performance indicators (KPIs) in measuring results. KPIs offer hints to the levers the company can pull to improve them. Thus, overall sales make a poor KPI, while sales per customer lets the company search for answers.
- Identifying risks that can drive variability in performance such as future customer demand.
- Establishing key risk indicators (KRIs) and tolerance levels for critical risks. KRIs are forward-looking leading indicators intended to anticipate potential roadblocks. The tolerance levels serve as triggers for action.
- Providing integrated reporting and monitoring.
Overall, strategic risk represents the greatest dangers and opportunities of a certain company faces.
Risk management strategies are vital for every traders and companies in the competitive market. It is very important because in order to make money, you have to learn how to manage potential losses.
For traders, trading without risk management strategies and rules, you are in fact gambling.
A practical example is the casino versus gamblers. Even though many people are winning jackpots, the casinos still make money because they rake in more money from the people who don’t win.
An above example shows how statisticians make money over gamblers. Although both parties lose money, the casinos know to control their losses.
Risk management will not only protect you. It can also make you very profitable in the long run. If you learn how to control your losses, you will have a chance at being profitable.
In summary, a trader or a company that doesn’t have concrete risk management plans and strategy organization cannot define its objective for the near future. If both didn’t put risks into consideration, chances are that they will lose direction once any of the risks hit home.
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