Financial Risk Management For Dummies

Part III

Managing Financial Risk

Three levels of risk limits

• Speed limit: This defines how much risk to take: how big to make positions; how much risk to hedge; how far to deviate from benchmark. Normal risk taking is expected to be near the limit.
• Centre line: Normal risk level that doesn’t require extraordinary attention. This is a normal low-risk condition that can be exceeded under specified circumstances if accompanied by heightened alertness on the part of the risk taker.
• Guardrail: An actual guardrail physically prevents you from going beyond a limit. A financial guardrail is a limit you should never violate. The main point of a guardrail is to prevent even a reckless, suicidal or unconscious driver from going over a cliff. Risk managers have these kinds of limits as well.

Delve into what a risk manager’s job encompasses at www.dummies.com/extras/financialriskmanagement.

In this part …

Set limits that allow your risk takers enough freedom to succeed, but not enough rope to hang themselves.

Know when to stay the course after losses, and when to pull the plug. You’ve got to know when to hold’em and when to fold’em.

Adjust risk to the right level after drawdowns erode confidence ...