There are various financial risks when it comes to trading. Financial risk includes losing money or assets. When speaking about trading or financial markets, the risk is the money that can potentially be lost along the way through trading or investing. It doesn’t refer to the loss but what can eventually be lost.
There are several types of financial risk, some being investment risk, operational risk, systemic risk, etc. Let’s discuss the different types of financial risk.
Types of Financial Risk
This type of risk refers to investing and trading activities. It is important to consider market liquidity and credit risks in this financial risk group.
Market risk relates to the volatility of an asset. For example, if a trader buys bitcoin, the market’s volatility can cause the price to drop; this is considered market risk.
Market risk falls under two categories; direct and indirect market risks. The loss a trader may experience as a result of an adverse change in the price of an asset is referred to as direct market risk. Indirect market risk, on the other hand, is about an asset that is a secondary or ancillary risk.
Liquidity risk is the risk that investors and traders cannot quickly buy or sell a specific asset without experiencing a significant price change.
Credit risk is the risk that a lender will lose money due to counterparty default. Looking at the bigger picture, this can happen when a nation’s credit risk rises to higher levels.
This type of risk is due to financial losses that are caused by failures in systems, procedures, or internal processes. These losses are due to human mistakes or intentionally fraudulent activity.
External events that indirectly impact a company’s operations, such as earthquakes, thunderstorms, and other natural disasters, can also cause operational failures.
Compliance risk happens when a company doesn’t follow the laws and regulations the authorities put for them.
To reduce such risks, many businesses implement specific procedures such as anti-money laundering (AML) and Know Your Customer (KYC).
If a service provider or company does not abide by the rules, it can face penalties or even be shut down. Due to compliance failures, many investment firms and banks faced lawsuits.
This risk is the possibility that an event can oppositely affect the market or industry. Diversification can help minimize systemic risk.
Now that we have discussed the type of financial risk, you know what to look for. When trading, there is no way to avoid risk altogether. The one thing that could be done is to control and beware of these risks. The first step is to understand the financial risks out there, and the second is to have a risk management strategy that will keep you away from them.
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