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A to Z Academy / 1. Things investors must know before trading

5.Understanding the risks of investment correctly

December 29, 2020 05:59 AM

Investment returns and risks


With the increasing development of information technology and the wide spreading of financial knowledge, most people have realized the importance of wealth management and investment.

When you first enter the market, you often hear that investment involves risks, so understanding risk is one of the topics that investors must learn before entering the markets.

So what is risk? Risk can be understood as market uncertainty, and uncertainty can be quantified as volatility. When investors are exposed to greater market volatility, they can expect higher returns. However, prices can go up or down, investment is a double-edged sword, so don’t overlook the fact that any potential higher return may also lead to bigger losses.

Before real trading, investors should first understand the risks they can bear, and the level of risk tolerance of everyone are different. In fact, most of them pay too much attention to the returns they can get, and are excessively optimistic and underestimate the investment risks. Once you get into the market, recognizing risks too late can lead to a series of bad decisions that can affect your investment mindset, leading to heavy losses or forcing you to leave the market.

Simply put, “the return on investment is proportional to the risk” is one of the iron laws of trading. Before entering the market, you need to be clear about relationship between the two. It is unrealistic to say that we want low risk and high return. But on the contrary, it is also unrealistic not to invest because of risks.

There is no risk-free investment


There are two types of risk in financial markets: unsystematic risk and systematic risk. Unsystematic risk comes from the investment target itself, and those risks faced by different targets are slightly different. Unsystematic risk can be reduced by asset allocation, that is, “don’t put all your eggs in one basket”. But, the risk can only be dispersed and not completely eliminated. Systematic risk, on the other hand, cannot be dispersed. It is a market risk, mostly related to uncontrollable factors such as politics, economic cycle and natural disasters.

Some people think there is no risk in buying US Treasury bonds or bank deposits, but that’s a fallacy. There is still the possibility of default, no matter of holding Treasury bonds or making fixed deposits. The US government or financial institutions still have the opportunity to collapse, so-called “Black swan event”. It’s just that compared with other underlying risks, such a situation is unlikely to happen, and the risk is close to zero which can be ignored.

At the same time, we still need to take inflation risk into account. When inflation is high, or when overall asset prices are on a long-term upswing, the real return on bonds and fixed deposits will be lowered. From the perspective of purchasing power, the real return may be even negative in some cases.

Therefore, there is no such thing as zero risk in the world. Not knowing how to invest may be the biggest risk. If you never learn the financial markets, how can you understand the operation behind, and the possible risks?

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5.Understanding the risks of investment correctly - ZFX


Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted in accordance with this article. Please be firm in your thinking and do the corresponding risk control.

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