Everything you always wanted to know about risk

Leave it to Tadas to find every worthwhile blog. Above the Markets fits that category, if his current series on Reckoning with Risk is any example.

The series tackles risk from several vantage points. Here are a few tasty excerpts:

Risk is anything but tame, benign, entirely predictable or fully controllable. It takes on different guises in different situations or contexts and is not susceptible to precise definition.

If you are likely to lose, you shouldn’t play.

Size matters. As in the example above, the size of your bets should relate to both the likelihood of winning and the stakes. In On the Waterfront, Marlon Brando as the boxer Terry Malloy offers his famous lament: Had he not taken the sure-thing “short-end” money – a relative pittance – to throw the fight, his upside potential was enormous, he ‘coulda been a contender.’

Of the all the advice offered, this is my favorite. I wish I had considered this possibility:

Once you have won, stop playing. Why risk damage and perhaps screwing up everything you’ve accomplished? When you have met your goal(s) it’s time not just to take risk off the table but to get out of the game entirely.

A sophisticated conclusion

We don’t do a very good job dealing with low-probability, high-impact events, whether hurricanes, early death, or market bubbles. We are consistently overconfident and, due to the bias blind spot, think these inherent problems may exist generally, but don’t pertain to us. At a minimum, this suggests that we might all be more cautious than we tend to be and that we all ought to consider the use of accountability partners since we all see problems and weaknesses in others far better than we see them in ourselves. We simply don’t deal with risk very well. Remember, risk is risky.

Mistake avoidance

Investing is a loser’s game much of the time – with outcomes dominated by luck rather than skill and high transaction costs. If we avoid mistakes we will generally win. By examining risk more closely, we’ll have a better chance of doing precisely that.

Since risk defies simple definition, today I am going to try to describe some of its elements, allowing us to approach it from different angles and perspectives, with the hope of ascertaining a more complete understanding:


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