TRADING PSYCHOLOGY

Personal Dimensions Of Risk Management

Evaluate Your Risk

by Simon Vine

To accurately determine risk, you must filter classical statistical factors. How, you ask? With a personal risk profile.

In classical statistics, risk is defined as the standard deviation from the mean. To some extent, this basic concept governs the minds of most decision-makers, including investors: A decision in a given situation carries a risk equal to the deviation from the average person's decision. Of course, it is anybody's guess as to what the average person's decision might be, so you cannot be certain how far away you are from the average. Thus, there is incongruence between a generally acceptable conceptual framework and the real-life behavioral aspects of decision-making. If decision-makers forget that the concept of risk is always individual in nature, their decisions become riskier and less realistic.

Different people (and companies) evaluate the risks of situations differently. It's similar to fitting a suit: The suit may be your size, but it may not fit well when you actually put it on. All other things being equal, people treat risk differently - statistical measures often do not help. For example, the risks associated with a small child crossing a road are higher than those involving an adult, although objectively they are on the same road and may be hit by the same car.

The same applies to the financial markets. Most market participants have the same access to market information and trading methodologies, but there are huge discrepancies in the results. The reason for this is the individuality of all decision-makers. The ability to adapt common knowledge to personality is one of the most important characteristics of a successful trader.

...Continued in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES

Excerpted from an article originally published in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.


Return to October 2002 Contents