Risk and more importantly your own risk profile is something new stock investors rarely consider.
Having a sound understanding of your risk profile will help you to determine which asset classes (cash, bonds, stocks, real estate, etc) are most suited to you.
Risk can take on many different forms in investing.
From an investment perspective, it is simply defined as the variation of return.
This is important to understand, it is the amount of change (variation) in expected return.
Another way you can look at it is too consider it as the likelihood of loss (or less than expected return).
To better understand this, let us take a brief look at the risk and return relationship.
Low levels of risk are associated with potentially lower returns (low variation).
On the other hand, high levels of risk are associated with potentially higher returns (high variation).
According to the risk-return trade-off, an investment can deliver a higher return only if it is subject to the possibility of being lost.
Your expectations for return and the way you react to and respond to loss will depend on your risk profile.
Your risk profile is basically how comfortable are you with different levels of investment risk? Different profiles are better suited to different types of investments.
At one extreme is the risk adverse investor who is looking for the capital security offered by low risk investments (cash, fixed interest and Government bonds).
At the other end of the spectrum is the risk seeking trader who is looking for high growth strategies (speculative stocks, options, futures, etc).
By being aware of your risk profile you can better: 1.
Appreciate the way you will respond (tolerance level) to the various risks inherent in the stock market; 2.
Develop an investment or trading style that is right for you; 3.
Choose stocks more suited to you; and 4.
Determine an appropriate position size for each trade based on your risk tolerance.
Failing to appreciate one's tolerance level is a common problem for the large majority of first time stock investors and traders.
By not having an appropriate level of knowledge and skill, the novice tends to seek out in appropriate investment or trading strategies.
It is important to appreciate that your risk tolerance (profile) may change over time.
Factors that can affect your tolerance level include: your age, knowledge of the markets, investment objectives and if you have any dependents.
Investing for beginners can be a time of numerous questions, uncertainty and great anxiety.
However, by understanding your risk profile, you can greatly increase you future long term success.