Various Risks in Trading and Investment

Trading and investment carry risk. The opportunities in trading and investment without risk rarely exits except some arbitrage opportunities, which will not be discussed in this book. In theory, you could develop several classes of risks for trading and investment. For example, risk in trading and investment can be classified as Macro and Micro risks depending on where they are originated. Macro and Micro risks can be subdivided further into smaller categories like the market risk, operational risk, liquidity risk, credit risk, political risk, etc. Since this book is not the theoretical textbook, we only describe some examples of Macro and Micro risks in Table 10-1 for your trading. However, this list is definitely not the exhausted one.

Risk Factors Description Examples Exposure on


Market Risk Risk of changing the fundamentals of the underlying security due to the competitive market environment. Microsoft Window is losing its market share due to the wide popularity of android OS developed by Google. Trader: Yes

Broker: No

Political risk Risk associated with the possibility of unfavourable government action or social changes resulting in a loss of the security value. Large change in the currency value and stock prices after the presidential election. Trader: Yes

Broker: Yes

Interest rate risk Risk that an investment’s value will change due to a change in the absolute level of interest rate. If interest rate increase, bond prices fall. When interest rates fall, then bon price rise. In addition, interest rate change cause huge spikes on Forex market too. Trader: Yes

Broker: Yes

Operational Risk Risk that originates from the mistake of the operator or the company during its trading and investment process. You have executed your order with wrong stop loss size or wrong contract size. Trader: Yes

Broker: Yes

Liquidity risk Risk that refers to the difficulty of converting the assets to cash at the fair value. You want to sell your 10 million shares of Google but your broker cannot find buyer of your shares because of the large volume. Trader: Yes

Broker: Yes

Credit risk Risk or possibility that the operator or company can go bankrupt. Your broker gone bankrupt so your trading account is suspended from trading. Trader: Yes

Broker: Yes


Table 10-1: Common risks for your trading and investment.

Trader and investor are exposed on both Marco risks and Micro risks every day. Macro risks like the market risk, political risk and interest rate risk are caused by the external factors outside your trading operation. Most of time, these external factors are not controllable by us. In fact, some of the technical and fundamental analysis might be used to protect traders from these Macro risks. However, some of the risky event can not be warned at all even using any technical or fundamental analysis. For example, trader can make some educated guess on the possible depreciation or appreciation of the currency by looking at some Macro-economic data and technical analysis. Likewise, by studying the company balance sheets and by applying many technical analyses, we can guess that if the company is increasing their market share from its competitors. On the other hands, guessing when the government will increase or decrease the corporation tax is impossible with any technical or fundamental analysis. Macro risks can contribute to the predictable and non-predictable parts of the market. In fact, many technical and fundamental analyses are there for you to reduce the Macro risks for your trading. Charting techniques and technical indicators can help you to identify the short-term or long-term price movement up to some degree. Besides the technical analysis, monitoring the important news can reduce the market risks too. For example, trader need to watch out any news about the taxes or labour laws, trade tariff change, environmental regulation or reformation in the national economy because they can change the entire market dynamics.

Some Micro risks like operational risk and credit risk can be originated from trader or from broker internally. In 2009, trader at UBS, the Swiss banking giant, placed a $22 billion of Capcom bonds in mistake while trying to buy just £220,000. In 2012, Knight Capital lost nearly $440 million in just 30 minutes because their trading software sent erroneous orders. These types of fat finger mistakes are the typical operational risk in trading. Operational risk can be made by anyone or by any algorithm. Sometimes, some trading platforms have many protective systems to prevent some common operational risk but not all of them can be prevented. You can still send wrong contract size or wrong stop loss size to your broker anytime. Especially the erroneous automated trading system can send the erroneous orders at high speed. The penalty from the mistake is always 100% yours. If a book was accidently dropped on your keyboard and hit the enter key sending the market order with 10 million contracts to your forex broker, you will lose a lot of money on commission even if you close the order immediately. You can not blame other people for this accident. To prevent the operational risk, trader needs to be highly cautious in their trading. It is better to avoid trading when you are not set for the trading. If you are working in a team, it is important to monitor each other to prevent such silly mistake. If you have to build the automated trading algorithm, the operation of the algorithm must be fully tested in the paper account first.

Credit risk is another Micro risk, on which both trader and broker are heavily exposed. Simply speaking, credit risk is the chance of experiencing the bankruptcy for the business organization. Any business organization can go bankrupt. Trader, broker or any liquidity provider can face the bankruptcy. The insolvency of the Alpari UK, currency broker, due to the Swiss franc turmoil in 2015 was a good example of the credit risk exposed by the currency brokers. From the trader’s point of view, trader can always lose their entire capital or nearly entire capital from their trading. If the operational risk can be considered as a mistake, credit risk often happens because traders are not educated or not experienced. Except that your account blowing was experimentally carried out on the small account for some educational purpose, this experience can cause serious damage to your finance. For traders, the credit risk is normally originated from the lack of understanding on the market volatility and position sizing.

Consider the aggressive trading example in Table 10-2, where the credit risk is amplified to blow your account. Your starting balance is 10,000 US dollar and pip value for EURUSD is 10 dollar per pip in this example. In this trading example, a trader used the aggressive trading volume for each trade. Luckily, he got the two winning trades increasing his account to 30,000 US dollar initially. Then his luck was run out losing all his account in next three trades. Can you imagine how he would feel in his first two trades? Can you imagine how he would feel after he lost all his account? In this trading example, his obvious mistake is to use the excessively large trading volume. This sort of mistake typically happens to starters who ignore to learn how the pip value and contract size relate the market movement to the profit and loss on his holding positions.

Order ID            Symbol Entry Volume in Lots Take Profit

in pips

Stop Loss in pips Trading Results Profit/Loss in Dollar per trade Total Profit/Loss in Dollar
1 EURUSD Buy 20 50 50 Win 10000 20000
2 EURUSD Buy 20 50 50 Win 10000 30000
3 EURUSD Buy 20 50 50 Loss -10000 20000
4 EURUSD Buy 20 50 50 Loss -10000 10000
5 EURUSD Buy 20 50 50 Loss -10000 0

Table 10-2: Aggressive trading example for trader A.

Now consider another trading example in Table 10-3. Starting balance and pip value is identical to the first trading example. In this trading example, the trader started with two lots. Unfortunately, the first two trading gone badly and he lost 2000 US dollar. He is definitely new to the game of trading. Therefore, he decided to chase the loss and increased his trading volume to 10 lots. Another bad trade comes and he lost another 5000 US dollar. Now his broker does not allow him to open the trading volume greater than 2 lots due to the margin requirement set for his account. Therefore, he cannot continue the gambling anymore. He is financially and psychologically exhausted only after four bad trades.

Order ID            Symbol Entry Volume in Lots Take Profit in pips Stop Loss in pips Trading Results Profit/Loss in Dollar per trade Total Profit/Loss in Dollar
1 EURUSD Buy 2 50 50 Loss -1000 9000
2 EURUSD Buy 2 50 50 Loss -1000 8000
3 EURUSD Buy 10 50 50 Loss -5000 3000
4 EURUSD Buy 2 50 50 Loss -1000 2000
5 EURUSD Buy 1 50 50 Win 500 2500

Table 10-3: Aggressive trading example for trader B.

The first and second trading example can happen to starters when they are trading on the leveraged products. In the first trading example, trader did not know how the fluctuation in the market affects the profit and loss of his holding position. Such information is summarized in the single quantity, the pip value for the leveraged products like Forex and Future. For example, if one pip value were 10 US dollar, then he would experience ± 10 US dollar in his position per 1 lot trading volume per 1 pip movement in the market. If his stop loss is 50 pips, then he could experience up to -50 US dollar loss per 1 lot trading volume. In addition, he could experience up to -500 US dollar loss for 10 lot trading volume. In the second trading example, it was the psychology triggered the aggressive trading volume later. If a trader is continuously exposed on the psychological bias like this, simply he can not win in the financial market.

About this Article

This article is the part taken from the draft version of the Book: Guide to Precision Harmonic Pattern Trading (Mastering Turning Point Strategy for Financial Trading). This article is only draft and it will be not updated to the completed version on the release of the book. However, this article will serve you to gather the important knowledge in financial trading. This article is also recommended to read before using Harmonic Pattern Plus, Harmonic Pattern Scenario Planner and Profitable Pattern Scanner, which is available for MetaTrader or Optimum Chart.

Below is the landing page for Harmonic Pattern Plus, Harmonic Pattern Scenario Planner and Profitable Pattern Scanner in MetaTrader. All these products are also available from too.

Below is the landing page for Optimum Chart (Standalone Charting and Analytical Platform).

Related Products