Risk management is the process of controlling your exposure to any one thing. Whether that thing be a business, relationship, etc., dictates how much of yourself is thrown into the venture and can be done by calculating how much you are willing to lose.
If it weren’t for trading, it would have taken me years to understand risk management.
How trading helped me learn about risk management
Most of the trading process involves risk management. Traders stay in the game by making sure that their wins far outnumber their losses. The only way that this can be done is by setting a very small stop-loss level and reversing the trade if the equity hits the stop-loss.
It is time to get out if the price of the equity hits your set stop-loss level; This is because the trade no longer conforms to your vision.
These principles of trading can, and should be applied to any venture. It doesn’t necessarily have to be a specific price point per se (because, that would-be kind of impossible to do. Unless you told yourself that you’re only willing to lose this much money on any one venture) but, I think that a stop-loss should be in place. The stop-loss that is placed is solely up to your discretion but, one should be in place.
Why I needed to learn about risk management
I wish that I understood this before I started doing any type of investing, trading etc. When I first started doing anything, I was what was known as a plunger. I would put my all into everything I did and, because I’m a relatively lucky individual I rarely ever got burned. This caused me to keep doing it. I didn’t learn that it wasn’t a very good idea to put all your eggs into one basket.(Especially if those eggs are your livelihood) Or at least don’t use all of your eggs at one time(I’m not big on diversification). This kept happening until the inevitable 3rd degree burns happened.
Listed below are my approaches to risk-management
1. Cut Losses as soon as possible
This is one of the most difficult things in the world (when you do this you’re accepting defeat. It’s literally painful). But, it’s necessary. And it means so much more than just getting out of a venture when you see that it isn’t working. To me, it means being okay with dropping everything and starting over.
Now, this isn’t an excuse to just start dropping things. (Meaning don’t start dropping things when they start getting difficult.) To successfully do this, we must have the perfect mixture of drive and elasticity in our decision making. Meaning that we must have enough drive to work hard at something yet enough elasticity in our decision making to drop something at a moment’s notice.
This may just be me but, I’ve noticed that things must be dropped when they no longer align with my vision. When I see that it wont be beneficial to continue doing it in either the short or the long term. Like in trading, when it no longer aligns with my vision I get out.
2.Change the lens through which the risk is seen
This helps us keep things in perspective so that it becomes easier to cut losses.
For example, when I’m trying something new, I think of myself as a scientist and what I’m doing as the experiment. This allows me to change the lens through which I view each activity. Which, in turn helps me maintain the necessary amount of elasticity and drive.
Rather than completely tying my emotions to whatever venture I’m engaged in at any specific time, I think of everything that I do in terms of positive and negative results. This, also allows me to focus on the process. Meaning that I focus on the reason that I get negative results rather than the results themselves.
Example of how changing the “risk lens” works
I said that I separate myself from my losses by thinking of ever attempt that I make as an experiment. One that takes one of three courses; It fails horribly, it works but not in the way that I’d intended, or it works in exactly the way that I thought that it would. In two of these cases I chalk it up as a W; one where it works, and my hypothesis was correct and one where it works but my hypothesis was incorrect which means that I have new information to add to my research. The failure is obviously not counted as a W and means that I have more research to do.
The interesting thing about all three outcomes is that I learn something from all three. In two out of the three, I’ve gained money most likely and information in the form of positive results. In the last outcome I lost money but, in return have gained experience and a bit more information on the way things work. (Just in case you didn’t know, knowledge is always more valuable than money).
Risk management is the key to staying in the game.
Also, everyone is different so the way that I choose to manage my exposure may not work for your personality. But, I believe that developing a specific method will be extremely helpful overall in managing your risk.