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Avoidable risk is risk that can be avoided or reduced without affecting the potential gain. For example, risk of a bad fill can be reduced by using limit orders, avoiding markets with excess volatility, or avoiding markets with very little liquidity. Avoidable risk can also be reduced by proper diversification of the securities traded. We shall shortly see that trading in uncorrelated markets substantially reduces our avoidable risk. Order execution is an area in which many novice traders make mistakes, subjecting their equity to a certain amount of avoidable risk. There are huge differences between a day order, a good till cancel (GTC) order. Limit orders are quite different from market orders. There are procedures that a trader can implement to reduce this risk practically to zero. |
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Another area (although somewhat mundane) of avoidable risk is anticipating problems that are related to the process of placing orders with the brokerage house. Possible problems include the trading house phone lines going down, the Internet Connection failing, and adverse weather affecting the satellite feed. In all these cases, with proper preplanning the trader can reduce and often eliminate these types of risks. |
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As the volume of trades increases, a trader will occasionally lose money because of an avoidable risk that was not adequately taken care of. Sometimes it can be fairly mundane. I remember trading bonds off a tick chart in 1994, and suddenly my satellite feed crashed. After a quick phone call to a fellow trader to see if he was still getting his data (he was), I looked out the window and realized that because of my intense focus on the price action, I was oblivious to the fact that it was snowing rather intensely. I quickly ran outside to sweep the snow off my satellite dish. The point is that regardless of how much forethought you put into reducing and removing avoidable risk, occasionally an unplanned event will throw you off. |
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Certain risks are unavoidable without affecting the overall potential gain of a trade. There are two types of unavoidable risk: controllable and uncontrollable. |
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