What is a Financial Risk?
Financial risk is a term that is used to describe the ratio of earning loss during the trading process. Financial risks are dependent on various factors that determine the price movement of an investment product such as cryptocurrencies.
Trained investors describe financial risks as probability of losing their investment or going into negative value after creating a new trading position.
Financial risks are dependent on a broad spectrum of factors such as market sentiment, investor goodwill, and external influences. Investors aim to work on enhancing risk management skills in order to increase their profit percentage and mitigate associated risks.
Types of Financial Risks
Financial risk is an umbrella term that can comprise a vast array of concepts. Some important types of financial risks are mentioned as under:
Investment Risks
Investment risks are based on buying new trading positions or incrementing the existing trading portfolio. The investors may have to account for the associated risks involved when creating long or short positions on account of factors such as price volatility, liquidity, credit risks, and others.
Price Volatility
All investment products are subjected to market fluctuations. Cryptocurrencies are said to have a higher volatility in comparison to other trading options. Investors can calculate their exposure to market risk by working out the percentage of price changes.
Market risks can be divided into direct and indirect risks. Direct risks stem from the loss of investment value on account of changes in the spot market prices of a given asset.
On the other hand, indirect risks are also known as secondary or ancillary risks. For example, the changes in interest rates from Central bank can impact the shares prices in the stock market.
Liquidity Risk
Liquidity is the ability of an investment product to be converted into cash or other tradeable assets. Whenever investing in a given token, investors are exposed to loss of liquidity. When an asset class loses its liquidity, the prices of the product are impacted in a negative manner.
Credit Risks
Credit risks are associated with leveraged positions. Margin traders tend to borrow funds to maximize their profits by increasing the trading volume. Trading with borrowed funds automatically increases the risks exposure by several folds.
For the most past, only trained traders take up leveraged positions and usually deal in short term positions that grant them greater protection against managing market fluctuations.
Operational Risks
Operational risks are based on the internal management and development of a given investment issuer. In the case of stocks, companies that issue the stock can face internal failures leading to the loss of stock value. In the same manner, blockchains can also suffer from technical errors or cyber-attacks that can have a negative impact on their token valuation.
Therefore, blockchain entities incorporate technical audits to locate any technical blind spots in advance and ensure greater security for the investors. In some case, operational risks can be traced back to mismanagement or fund misappropriation that exposes the investors to unwarranted risks.
Compliance Risks
Investment products and services providers are subject to regulatory security. However, cryptocurrencies are decentralized entities that set them apart from the traditional financial instruments.
On this account, various crypto trading platforms have talked about the lack of proper regulatory framework.
On the other hand, centralized cryptocurrency exchanges implement checks such as AML (anti-money laundering) and KYC (Know your customer) checks for account registration to comply with financial regulators and ensure the legitimacy of investors.
Systemic Risks
Systemic risks are based on the collapse or decline of major firms that are associated with a given trading industry. For example, the fall of Lehman Brothers in 2008 led to wider financial crisis.
It is important to note that systemic risks are distinct from systematic risks that are based on economic and sociopolitical factors such as interest rest, law and order situation, policy changes, natural disasters, inflation, etc.
Conclusion
The goal of investors is to understand all types of risks associated with a trading instrument. In this manner, investors can edit and upgrade their risk management strategies and mitigate the risks of losses that can impact their profit.
