The Risk of Trading: Mastering the Most Important Element in Financial Speculation

STEP ONE: RISK IDENTIFICATION

Considered the most important step in the risk management process, risk identification, or the process of identifying and examining potential exposures to loss in trading, is the first step. (See Figure 2.2.) Why so important? Simply put, if a risk is not identified, it cannot be assessed for impact, controlled, measured, or administered. What you don't know in trading can certainly hurt you. One of the skills required of a risk manager is to have an “anything can happen” mind-set and be prepared to run any potential exposures through the risk management process. Red audit flags go off on all trading plans that only include historical losses as worst-case scenarios, the reason being that the inevitable next bigger loss becomes the new worst-case scenario. No doubt the more visionary talent one possesses, the more capable one is of excelling at risk management. It's also advantageous to be a bit creative during the identification process. If you are an independent trader, no boss will chuckle at your silly scenario of asteroids hitting your data server during a short trade with no stop. While working on an emergency evacuation plan for an operation on top of a steep hill, I was laughed at when the need for stored overnight supplies and blankets was identified should the primary access road be cut off from access for any reason. Although there had never been any exposure in the past, a large commercial development blocked an auxiliary exit with a smaller ...