Author Topic: RISK  (Read 433 times)


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« on: August 29, 2017, 08:13:12 PM »
What is risk?

Its one of the most misused and misunderstood terms in investing IMO.

In its simplest form, risk is the potential for something to happen that has negative consequences.

Perhaps it helps to think what its not, risk is not opportunity - opportunity being the potential for something to happen that has positive consequences.

So in finance risk takes many forms, we have the risk of capital loss - surely the most critical risk and the one we should assess foremost.

We have the risk of opportunity cost - if we dont invest our capital it has zero or very low returns.

Interestingly you can invest to avoid either loss of capital, or to avoid opportunity cost - but you cant invest to avoid both of them.

In order to avoid the risk of zero or low returns, we must risk the loss of capital. This is a critical understanding.

Some other forms of finance risk are sovereign risk, FX risk, default risk, catostrophic risk, liquidity risk, legaslative risk....

We should consider which risks we can put controls in place that may help mitigate. An example is liquidity risk, some investors are very nervous about liquidity risk and avoid illiquid stocks - which is a form of control. Its also possible to control liquidity risk by psychology and appropriate position sizing as well as only investing capital that wont be required at short notice.

Legaslative risk is an interesting one, again investors often use the control of simply avoiding businesses that have high legaslative risk that is obvious by existing controls and laws directley related to the business. But in actual fact the risk may already be priced in, and its worth remembering that any business can become subject to negative legislative control at the whim of governments and regulators. One could argue the risk is best avoided by investing in heavily regulated businesses where the legaslative risk is already quantified.

I would argue some risks are best ignored, like political, economic and FX risk - its simply impossible to imagine all the things that can happen that might have a negative impact, and they mostly have opposite potential things that may happen that can create opportunity. For this reason I am very dismissive of hedging.

These words of wisdom from Howard Marks resonate,

Risk means more things can happen than will happen

Even if you know whats most likely, many other things can happen instead.

Risk means uncertainty about which outcome will occur and about the possibility of loss when the unfavorable ones do.

“The riskiest things: The greatest risk doesn’t come from low quality or high volatility. It comes from paying prices that are too high. This isn’t a theoretical risk; it’s very real.”

“When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all. Broadly negative opinion can make it the least risky thing, since all optimism has been driven out of its price.”

“This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky.”

« Last Edit: August 29, 2017, 08:17:21 PM by galumay »


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« Reply #1 on: June 20, 2018, 07:16:11 AM »
"Risk is the likelihood of permanent capital loss. Opportunity risk is the likelihood of missing out on potential gains. Put together you'll see that risk is the possibility of things not going the way you want. " Howard Marks