3 main types of risk in trading

Whenever you engage in trading, you encounter various risks. It's essential to understand the three primary types of risk that traders face and the strategies for managing each effectively.

The three main categories of trading risk:

1. Market Risk
2. Liquidity Risk
3. Systemic Risk

1. Market risk

The term market risk, also known as systematic risk, refers to the possibility of incurring losses due to fluctuations in overall market conditions, which can cause the price of your underlying asset to move unfavorably in ways you did not anticipate. Price volatility often arises due to unanticipated fluctuations in factors that commonly affect the entire financial market.

Here are some methods to manage market risk:
1) Beginners might find it challenging to navigate the market effectively, before crafting a market strategy, determine the level of risk you’re comfortable with.
2) Diversification of your asset classes can assure that a loss in one area will be offset by stability or gains in others.
3) Hedging gives traders the right to sell your stock at an agreed-upon price if its value begins to dip.
4) Stay up to date on the market, be aware of market changes and how fluctuations might affect your investments.

2. Liquidity risk

Liquidity refers to how easily an asset in a market can be boug

ht or sold without causing a significant change in its price. It depends on the volume of capital flowing in and out of the market, including the level of buying, selling, and speculating activity at any given time. When a market is illiquid, traders face liquidity risk.

Here are some methods to manage liquidity risk:
1) Markets with deep liquidity will very seldom have slippage, these market will perform calculations to assess liquidity ratios
2) Choose markets that historically have shown resilience of market liquidity during times of macroeconomic stress
3) Choose a broker that is known for their very fast execution times.
4) Ensure you’re trading on a fast and dependable connection and device so that you can avoid ‘slippage’, which causes a delay in your computer or device being able to make that order

3. Systemic risk

Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it denotes the risk of a cascading failure in the financial sector, caused by linkages within the financial system, resulting in a severe economic downturn.

Here are some methods to manage liquidity risk:
1) Carefully calculate the sizes on your positions to ensure you’re not opening trades that would represent a substantial loss for you to recover from, should the market shift
2) Have a stress-tested risk management plan ready to go at all times, that can work for a variety of different asset classes and scenarios,
3) Always consider setting up stop-loss orders and take-profit orders that can help protect you against excessive losses or secure potential profits at predetermined profit targets.
4) Keep up to date with significant macroeconomic news of the financial markets, to know early on when uncertainty may be brewing in the markets

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.