2 Types of Risk Pros Use One, Novices the Other

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2 Types of Risk: Pros Use One, Novices the Other

We typically view risk as how much capital we stand to lose if we lose on a trade. This is our trade risk. I don’t risk more than 1.5% on a trade, typically less than 1%. If you are trading with a $5000 account, and risk 1% that means you can lose $50 on that trade. That is your dollar or trade risk.

But there are other types of risk in trading, associated with how we choose which trades to take.

Consider the following example. You want to buy the EUR/USD, and based on your analysis, you have a specific price you want to buy it at. But as the EUR/USD declines toward that level you are faced with two choices:

  • Buying at the price you set
  • Not buy at the set price and instead wait to see if you can get a bit better price, or wait for more information from the market to determine when you enter

Most traders don’t consider this choice a risk, but it is. And the risks associated with these choices are called Information and Price risk, respectively.

The example applies to any strategy or scenario. The key element of the example is this question: For your trades, are you taking planned entries, or when entry time comes are you altering it?

Information Risk

Information risk is when you take a price, based on your analysis and strategy, that you believe is a good entry point. You are giving up the prospect of attaining additional information. This is why it is called information risk. Had you waited another few minutes to take the trade, more price data is available and thus more information to make your trading decision with. But you have your trade, based on your strategy, with defined risk and rewards, so you are willing to give up potential new information.

Price Risk

Most traders want lots of confirmation for a trade, but confirmation comes at a cost. By waiting for more information it is possible you may get a better price, you may also end up with a worse one, or miss the trade completely. Price risk is when you alter your plan in an attempt to increase profits, get a better entry, etc.

Notice the Difference?

Most novice traders take on lots of price risk in that they wait for all sorts of stars to align before taking one trade they hope will work out.

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Professional traders on the other hand, don’t need as much confirmation from the market. This is because they follow a plan, and a few minutes of additional information doesn’t change the trading statistics of a strategy over time. Two minutes of extra information isn’t worth missing a trade for, so they take a trade as planned, at a planned price and that is it.

If a trader is taking on price risk–that is, always looking for more information, confirmation and a better price–there is a tendency to trade with no plan at all! If an entry point looks good, but then you waffle and wait for more confirmation, then your strategy is changing with every trade. Changing your strategy on every trade can only lead to inconsistent performance.

Love Uncertainty

Pros take information risk because they are willing to take a trade without knowing what is going to happen next. Pros know that they don’t know what is going to happen next. Therefore, they trade according to the plan which is proven to have a slight profitable edge, and trust in that. They give up the need for more information because an extra minute of information won’t help the statistics of their strategy over a great many trades.

Novice traders hate risk, and don’t won’t to lose on this trade (and every trade taken is THIS trade). So they wait for lots of confirmation and try to cherry pick the best entry point. In theory it may be appealing. Why buy at 1.2588 when a few seconds later you can buy at 1.2585? But you then need to ask yourself, if you were supposed to buy at 1.2588 and didn’t, why would you buy at 1.2585…or any price for that matter?

There is always a continual stream of new information coming available. Pros don’t care. They trade their strategy. Novices try to cherry pick, and it is a stressful and frustrating way to trade because what was a good price one second, isn’t the next.

Final Word

Give up the need for certainty. Take your trades, based on your strategy, with conviction. Give up the need for more information or a better price. Pros know they will lose sometimes and so they play the odds, and don’t waffle on entries or exits. All trades are made according to a plan, and aren’t adjusted at the last minute.

Strategies, entries and exit tactics will vary by trader, but as a general rule you’ll find pros take information risk and just take the trade (being ok with uncertainty), while novices and unsuccessful trader take price risk, requiring more information but in the process giving up any sort of edge they have in the market.

The Main Types of Business Risk

Businesses face all kinds of risks, some of which can cause serious loss of profits or even bankruptcy. But while all large companies have extensive “risk management” departments, smaller businesses tend not to look at the issue in such a systematic way.

So in this four-part series of tutorials, you’ll learn the basics of risk management and how you can apply them in your business.

In this first tutorial, we’ll look at the main types of risk your business may face. You’ll get a rundown of strategic risk, compliance risk, operational risk, financial risk, and reputational risk, so that you understand what they mean, and how they could affect your business. Then we’ll get into the specifics of identifying and dealing with these risks in later tutorials in the series.

1. Strategic Risk

Everyone knows that a successful business needs a comprehensive, well-thought-out business plan. But it’s also a fact of life that things change, and your best-laid plans can sometimes come to look very outdated, very quickly.

This is strategic risk. It’s the risk that your company’s strategy becomes less effective and your company struggles to reach its goals as a result. It could be due to technological changes, a powerful new competitor entering the market, shifts in customer demand, spikes in the costs of raw materials, or any number of other large-scale changes.

History is littered with examples of companies that faced strategic risk. Some managed to adapt successfully; others didn’t.

A classic example is Kodak, which had such a dominant position in the film photography market that when one of its own engineers invented a digital camera in 1975, it saw the innovation as a threat to its core business model, and failed to develop it.

It’s easy to say with hindsight, of course, but if Kodak had analyzed the strategic risk more carefully, it would have concluded that someone else would start producing digital cameras eventually, so it was better for Kodak to cannibalize its own business than for another company to do it.

Failure to adapt to a strategic risk led to bankruptcy for Kodak. It’s now emerged from bankruptcy as a much smaller company focusing on corporate imaging solutions, but if it had made that shift sooner, it could have preserved its dominance.

Facing a strategic risk doesn’t have to be disastrous, however. Think of Xerox, which became synonymous with a single, hugely successful product, the Xerox photocopier. The development of laser printing was a strategic risk to Xerox’s position, but unlike Kodak, it was able to adapt to the new technology and change its business model. Laser printing became a multi-billion-dollar business line for Xerox, and the company survived the strategic risk.

2. Compliance Risk

Are you complying with all the necessary laws and regulations that apply to your business?

Of course you are (I hope!). But laws change all the time, and there’s always a risk that you’ll face additional regulations in the future. And as your own business expands, you might find yourself needing to comply with new rules that didn’t apply to you before.

For example, let’s say you run an organic farm in California, and sell your products in grocery stores across the U.S. Things are going so well that you decide to expand to Europe and begin selling there.

That’s great, but you’re also incurring significant compliance risk. European countries have their own food safety rules, labeling rules, and a whole lot more. And if you set up a European subsidiary to handle it all, you’ll need to comply with local accounting and tax rules. Meeting all those extra regulatory requirements could end up being a significant cost for your business.

Even if your business doesn’t expand geographically, you can still incur new compliance risk just by expanding your product line. Let’s say your California farm starts producing wine in addition to food. Selling alcohol opens you up to a whole raft of new, potentially costly regulations.

And finally, even if your business remains unchanged, you could get hit with new rules at any time. Perhaps a new data protection rule requires you to beef up your website’s security, for example. Or employee safety regulations mean you need to invest in new, safer equipment in your factory. Or perhaps you’ve unwittingly been breaking a rule, and have to pay a fine. All of these things involve costs, and present a compliance risk to your business.

In extreme cases, a compliance risk can also affect your business’s future, becoming a strategic risk too. Think of tobacco companies facing new advertising restrictions, for example, or the late-1990s online music-sharing services that were sued for copyright infringement and were unable to stay in business. We’re breaking these risks into different categories, but they often overlap.

3. Operational Risk

So far, we’ve been looking at risks stemming from external events. But your own company is also a source of risk.

Operational risk refers to an unexpected failure in your company’s day-to-day operations. It could be a technical failure, like a server outage, or it could be caused by your people or processes.

In some cases, operational risk has more than one cause. For example, consider the risk that one of your employees writes the wrong amount on a check, paying out $100,000 instead of $10,000 from your account.

That’s a “people” failure, but also a “process” failure. It could have been prevented by having a more secure payment process, for example having a second member of staff authorize every major payment, or using an electronic system that would flag unusual amounts for review.

In some cases, operational risk can also stem from events outside your control, such as a natural disaster, or a power cut, or a problem with your website host. Anything that interrupts your company’s core operations comes under the category of operational risk.

While the events themselves can seem quite small compared with the large strategic risks we talked about earlier, operational risks can still have a big impact on your company. Not only is there the cost of fixing the problem, but operational issues can also prevent customer orders from being delivered or make it impossible to contact you, resulting in a loss of revenue and damage to your reputation.

4. Financial Risk

Most categories of risk have a financial impact, in terms of extra costs or lost revenue. But the category of financial risk refers specifically to the money flowing in and out of your business, and the possibility of a sudden financial loss.

For example, let’s say that a large proportion of your revenue comes from a single large client, and you extend 60 days credit to that client (for more on extending credit and dealing with cash flow, see our earlier cash flow tutorial).

In that case, you have a significant financial risk. If that customer is unable to pay, or delays payment for whatever reason, then your business is in big trouble.

Having a lot of debt also increases your financial risk, particularly if a lot of it is short-term debt that’s due in the near future. And what if interest rates suddenly go up, and instead of paying 8% on the loan, you’re now paying 15%? That’s a big extra cost for your business, and so it’s counted as a financial risk.

Financial risk is increased when you do business internationally. Let’s go back to that example of the California farm selling its products in Europe. When it makes sales in France or Germany, its revenue comes in euros, and its UK sales come in pounds. The exchange rates are always fluctuating, meaning that the amount the company receives in dollars will change. The company could make more sales next month, for example, but receive less money in dollars. That’s a big financial risk to take into account.

5. Reputational Risk

There are many different kinds of business, but they all have one thing in common: no matter which industry you’re in, your reputation is everything.

If your reputation is damaged, you’ll see an immediate loss of revenue, as customers become wary of doing business with you. But there are other effects, too. Your employees may get demoralized and even decide to leave. You may find it hard to hire good replacements, as potential candidates have heard about your bad reputation and don’t want to join your firm. Suppliers may start to offer you less favorable terms. Advertisers, sponsors or other partners may decide that they no longer want to be associated with you.

Reputational risk can take the form of a major lawsuit, an embarrassing product recall, negative publicity about you or your staff, or high-profile criticism of your products or services. And these days, it doesn’t even take a major event to cause reputational damage; it could be a slow death by a thousand negative tweets and online product reviews.

Next Steps

So now you know about the main risks your business could face. We’ve covered five types of business risk, and given examples of how they can affect your business.

This is the foundation of a risk management strategy for your business, but of course there’s much more work to be done. The next step is to look more deeply at each type of risk, and identify specific things that could go wrong, and the impact they could have.

It’s not much use, for example, to say, “Our business is subject to operational risk.” You need to get very granular, and go through every aspect of your operations to come up with specific things that could go wrong. Then you can come up with a strategy for dealing with those risks.

We’ll cover all of that in the rest of the tutorials, so stay tuned for the rest of the series on how to manage risk in your business. Next up is a tutorial on measuring and evaluating different risks.

The Top Six Teen Risk Behaviors

It’s true that teens are going to engage in some sort of risky behavior. It goes hand in hand with their need to explore, discover, and grow, a psychological and emotional necessity at this stage in life.

The Center for Disease Control (CDC) is an organization that protects America from healthy, safety, and security threats. Among their many tasks and large-scale projects, they maintain research and health statistics on adolescents. For instance, the Youth Risk Behavior Surveillance System monitors six priority teen risk behaviors that play a role in the causes of death, disability, and social problems among teens and adults. These behaviors often begin in childhood or early adolescence and are listed below:

1. Behaviors that Contribute to Unintentional Injuries and Violence

According to the CDC, there are certain risky behaviors that lead to unintentional injury, such as riding a bicycle without wearing a helmet, not wearing a seatbelt when riding as a passenger in a car, riding in cars with drivers who had been drinking, and texting or emailing someone while driving a vehicle. Furthermore, the CDC recognizes behaviors among teens that specifically lead to violence such as carrying a weapon, carrying a gun specifically versus other weapons, being in a physical fight, experiencing being hit, slapped, or physically hurt intentionally by a boyfriend or girlfriend (dating violence), avoiding school because of its lack of safety, experiencing bullying, or considering and/or attempting suicide.

2. Sexual Behaviors That Lead to Unwanted Pregnancies or Sexually Transmitted Diseases

In addition to the behaviors listed above, there are risk factors that contribute to unintentional pregnancies and diseases, such as having intercourse before the age of 13, having multiple partners, not using protection during intercourse, not being tested for HIV, drinking alcohol or using drugs during or before intercourse.

3. Alcohol or Drug Use

Risky behaviors regarding alcohol or drug use include having at least one drink during their lifetime, currently drinking on a regular basis, having five or more drinks in a row (binge drinking experiences), trying other drugs such as cocaine, inhalants, heroin, methamphetamines, steroids, or prescription drugs.

4. Tobacco Use

Behaviors that lead to tobacco use include trying cigarette smoking, smoking an entire cigarette before the age of 13, smoking a cigarette at least once in a week, and using various forms of smokeless tobacco.

5. Unhealthy Dietary Behaviors

Risky behavior that leads to unhealthy diets include not eating the right amounts of fruit or drinking fruit juices, not eating any vegetables, not drinking milk, drinking sugar based drinks such as sodas, not eating breakfast.

6. Inadequate Physical Activity

Risky behavior that leads to lack of physical health is not getting enough exercise, which includes the following risk factors: not doing any cardio activity in the last week, not attending Physical Education classes, playing video games or spending time on the computer for 3 or more hours per day, watching television for 3 or more hours per day.

Although it is natural for teens to explore, when some of these teen risk behaviors become habitual it can be dangerous. The CDC keeps tracks of the leading causes of death among teens with respect to the risky behaviors described above. For instance, in 2020, 12,341 adolescents between the ages of 15-24, died due to an unintentional injury; 4,678 died due to homicide; and 4,600 died because of suicide.

Knowing these teen risk behaviors can help keep teens safe and prevent injury, violence, or even death.

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