Investing is all about risk. There are no guarantees in the market, but there are ways to take measured risks that are likely to yield good returns. Before investing, it is important to measure the current market risk.
The risk can then be avoided or perhaps mitigated. But, how do you do this? Keep reading for a guide to measuring financial market risk.
1. Historic Volatility
It’s impossible to determine the future of a financial security by looking at past performance, no matter how tempting this may be. But, it is helpful to look at its historic volatility to make an estimate of how likely the value is to change suddenly.
Using the standard deviation of data, you can measure how likely it is that a certain value will be reached in a certain time frame. This doesn’t tell you for sure what’s going to happen, but it gives you a percentage that the value will change by a given amount.
This is useful especially to determine if the market is likely to shift a lot in either direction.
2. Beta Measurement
The beta measurement tells you how volatile a specific investment or sector of the economy is compared to the market as a whole. The market in general is set to a value of 1, and a specific security is then compared to that measure.
If its value is higher than 1, the security is more volatile than the market. If it’s less than 1, it’s less volatile. Depending on the type of risk you’d like to take, you may be looking for a certain level of volatility.
3. Sharpe Ratio
The Sharpe ratio shows how the rate of return of a security compares to its risk. It involves making a calculation to isolate the rate of return that is the result of risk-taking.
So, the measurement method takes into account how much of the success the investment has had is due to certain risk-taking activities. This helps you understand the risk involved.
4. Value At Risk
This measurement tool looks at the potential level of loss associated with a certain investment in the market and the likelihood it will happen in a certain timeframe.
This is useful for companies in determining their level of risk of loss, and if they have enough assets and cash on hand to weather the potential loss.
5. Price Rate of Change Indicator
The rate of change measurement looks at the percent change in price from now compared to various points in the past. It is a way to quantify price momentum. The momentum is important since it can be used to confirm other market indicators.
Learn More About Market Risk
To learn more about market risk management, consider studying for and taking the FRM (financial risk management) test. Earning this certification means you have studied market risk and have the tools to evaluate risk before you make an investment.
There is no way to know the future for sure or to avoid all risk. But, learning the right measurement tools can help you manage the risk and make good investments!
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