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.
