Course Introduction

Investing can be risky. But what is risk and is it always a bad thing? The “official” definition of risk is being exposed to something that is dangerous or could put you in peril. Applying it to the financial markets, risk can be seen as putting your capital into a situation where it is worth less than it was previously. With risk, however, comes the opportunity for reward.

Let’s talk through a few real-life examples of risk and reward that you may be more familiar with. Assume you are software engineer working for a large company. You are comfortable with your team, the direction of the company, and the salary and benefits you receive. On LinkedIn, you are approached by a recruiter from another company. Let’s say that this other company is a well-known, fast-growing startup that many of your peers would want to work for. You decide to go through the interview process and you get an offer! And it isn’t “just” an offer; your compensation will rise by over 50% by taking the role. Even better, you will be in a junior management position allowing you to further grow your career. Taking this offer is a risk. Yes, the offer comes with a higher salary and title but what is the work environment really like? Will your supervisor be a micromanager? Is the culture extremely political and cutthroat? Is there a chance that the fortunes of this fast-growing startup could be easily impacted by any change in the broader economy? On top of this, you have institutional knowledge at your current company – you know how things work and who to go to if you ever need help. You need to ask yourself the question: is the risk of the unknown work environment worth the increase in compensation (reward).

Taking this one step forward, perhaps while working for the large company, you identify a way to do something better. You believe this to be a very lucrative opportunity. You know that there is no way your company would make such a change on its own. The only way to make your idea a reality is strike out on your own and start your own company. The risks of quitting your job to build your own startup are more easily identifiable than if you were to simply move to another company. You will lose your salary, benefits, and you will have the initial costs of building your company and acquiring your first customers. This is a daunting, high-risk task! Of course, you don’t read about too many corporate employees that become billionaires. Outside of inheritance, the only approach to becoming extremely wealthy is to start a company. Unfortunately, there are far more startups that go bankrupt and shutdown than those that grow to become multi-billion-dollar enterprises. Again: risk versus reward. Only this time, you are risking far more for the slight chance to have far greater reward than a 50% increase in salary.

Here is one final scenario. Assume you decline the startup offer and decide against building your own startup. However, a co-worker is interested in pursuing the idea. While you don’t want to take the risk of leaving your current role, you decide to provide financial assistance to your co-worker in exchange for partial ownership of the startup. You see this as the best of both worlds. You can participate in any significant upside that the startup could have but you maintain the stability of your current role. You do realize that there is a high chance that your co-worker’s startup will fail. In this case, the capital you provided won’t be repaid. But for you, this is an acceptable risk. You have the opportunity for significant upside and your financial risk is limited to the amount of financial assistance. In the other two scenarios, your financial risk wasn’t capped. If you took the higher paying startup job and you didn’t like it, would you be able to quit and find another job? The same thing is true about building the startup for yourself. If it fails, how hard will it be to get employed somewhere else?

In these three hypothetical situations, you balanced the risk and rewards of what to do next. Ultimately, the decision is based on your personal risk tolerance. Simply put, risk tolerance is how comfortable you are with loss. In our scenarios, you were fairly risk averse – you preferred stability versus uncertainty. It is a trade-off of risk and reward. But just because there is a risk-reward trade-off, you should never take unnecessary risks. For instance, you probably wouldn’t quit your job to start a company but have no ideas about what you will build. And you certainly wouldn’t do this if you had no savings. This would be an unnecessary risk.

An interesting point about risk is that sometimes not taking risk can be costly. What if you instead decided to keep your current role and not take this offer for higher salary or any other company’s offer for higher pay. At some point, you will be significantly underpaid by comparison. Not taking the risk of moving to a new company with a higher salary is known as an “opportunity cost”. For instance, had you taken the new job, then you would get the higher salary. You could then allocate a portion of that higher salary to fund your co-worker’s startup idea. This would provide you the best of both worlds. But by doing nothing, you could be potentially setting yourself up to be in the worst overall position in the future.

There are time tested rules that we want to share with you in this course. Even though this course is titled as ‘Trade Risk Management’, these rules are for both investors – those looking to buy and hold for the long term – as well as traders – those who are actively looking for profit opportunities in the market. Here is a preview of our rules of trade risk management:

• Never risk more than you can afford
• Always plan your trades
• Spread your capital across multiple investments and trades
• Limit your downside
• Consider “safe haven” investments

Throughout this course we will cover each of these rules in-depth through multiple lessons. In addition to this, we will also dive deeper into different types of risk and how the financial markets compensate you for taking these different types of risks. Hopefully by the end of this course, your will be more comfortable with the concept of risk and how you can be smarter with your capital.