Risk is a major part of trading. Not only do most traders need to actively manage risks that arise from their trading (market risk) but the actual processes in the trade lifecycle carry various types of risk. Here we present an introduction to the concept of risk in general.
The German sociologist, Niklas Luhmann, defined risk as “the threat or probability that an action or event will adversely or beneficially affect an organisation’s ability to achieve its objectives”.
In the financial services industry, the term risk often denotes the market risk of holding trading positions. Risk management is then the action taken by traders to control this risk. This is an important type of risk and one to which we will devote a chapter of this book (Chapter 10), but it is by no means the only source of risk to an organisation engaged in trading. Whenever we use the unqualified term risk, we mean the wider connotation of risk as in Luhmann’s definition.
2.2 RISK IS INEVITABLE
Imagine you own £ 10 000 in cash and decide to store it in the proverbial shoebox under the bed. You are now certain that you have protected your money - there are no risks attached. Correct? Unfortunately, things are not quite as safe as you think. Firstly, it could get stolen or there could be fire or flood. Secondly, if you leave the cash there long enough, the denomination of the bank notes could cease to be legal tender and banks and shops refuse to accept them. Thirdly, inflation of ...