Issue: 32
Sent: 20-03-2006 10:33:00
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What is Risk? - Lester Wills
This is the first in a series on risk that will; challenge your thinking on the topic and hopefully provide some insight into what to do, and as importantly, what not to do.
So, what is it about investing in the market that makes people irrational? I believe that decision making in connection with money is not a rational exercise. Even so, I am continually amazed by the way intelligent people will continually ignore basic logic and try to defy the odds.
Many like to try their luck. This is not a problem if they are prepared to accept the risk and/or have an understanding of what they are doing. Unfortunately sometimes people continually undertake such activity when they do not understand the risks they are taking, and then complaining that they have been ripped off.
The simple thing that so many forget is that no market runs in a straight line, even when it is rising it goes through a series of ups and downs but with an upward trend. The same applies when a market has a downward trend. There are always a series of ups and downs. A good trick is to pick the highs and lows each time. Ideally a person buys on the lows and sells on the highs.
Unfortunately all too often people buy on the highs and sell on the lows. We have all heard many stories of people boasting about their winning trades. What they often forget to mention is all the losses they had along the way which usually have more than mitigated any profit from their odd win.
What the average investor forgets is that investing is a zero sum game. For every winner, there is an equal and opposite loser. Added to that is the fact that there are countless thousands of professionals trying to do exactly the same thing. The main difference is that the professionals do this for a living.
They are often trained and have at their disposal some of the most sophisticated computer software and information networks in existence. They are likely to have real time access to exchanges around the world 24/7 and can call upon numerous experts to interpret the information for them.
Whereas the average investor is fairly restricted in what they can buy and sell, these professionals are able to avail themselves of a vast range of instruments. The can utilise innumerable options, futures, forwards, swaps and goodness knows what else. Consequently, in theory they can control their risk in ways that are simply not available to the average investor.
Despite all this, they still get it wrong, and in some cases spectacularly so.
Remember Barings and a certain futures trader called Nick Leeson?
Apart from the fact that all sorts of controls, stops and balances failed and sheer greed took over, the X factor really brought him down.
In the year prior to the collapse, the Board of Barings commented in their annual report that they had made very significant profits in their far-east operation due to a highly talented trader operating out of Singapore. The same controls were failing then but no one appeared to be too concerned as profits were being made. Once the smelly stuff hit the fan it was every man for himself in the mad scramble to get out and deny all knowledge of the "Rogue Trader"
The X factor that finally crushed the over stretched Nick Leeson by the way was an earthquake. The Kobe earthquake prevented the recovery in the Japanese economy that Leeson was counting on.
Risk is something we all live with to one extent or another, but few actually appreciate just what it is and fail to recognize it when they encounter it.
Risk can be all pervasive and many think it only relates to the "downside", a little like the "dark side of The Force". Unfortunately as illustrated above, that is a highly dangerous assumption to make. Risk is just as prevalent on the upside.
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