In the capital market, risk is defined as the willingness to accept the possibility of loss, the ability to accept market fluctuations, and the inability to predict what will happen next. Technically, risk appetite refers to the maximum amount of risk you, as an investor, are willing to take to achieve your goals before the risk outweighs the rewards.
We all face some level of risk in our daily lives, whether it’s just walking down the street or investing in the stock market. Your risk appetite is influenced by your age, income and investment goals, and is likely to change over time.
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For example, when you are young, it is obviously true that you don’t bother to take higher risks, but if you are a bit older, you will think of so many pros and cons to the results.
The capital market is a segment of the financial market that offers investors the opportunity to invest in long-term securities such as stocks and bonds. However, for short-term investments like day trading, every investment involves some level of risk inherently.
Here it shows you lucrative earnings in a day. However, 70-80% of day trading ended in losses. Therefore, investors should understand the total amount of risk they are taking and should adjust the total amount of return accordingly. Otherwise, the investment decision would not be fruitful.
Over the years, I have found that when a new investor comes to invest in the Bangladesh capital market, the majority of investors tend to rush. The tendency is to feel like it’s the last chance to get rich. The psychology is that the stock market is going to close next month, so I have to make the most of it to get rich. However, the reality is a little harsher and different from people’s perceptions.
Because of this perception, the objective of investors becomes to make a quick gain in the market despite any appetite for risk. Thus, investors become risky investors themselves when they invest in risky companies, obviously increasing market volatility.
The capital market in Bangladesh is indeed very volatile compared to other frontier markets in the world. The idea here is that investors tend to day trade more than invest for a certain period of time.
It’s not bad to have day trading; it happens all over the world. The bad idea is that you can’t expect an overnight miracle to double or triple the capital gain of your initial investment in a matter of days.
When an investor comes into the market with such an appetizer or need, it apparently becomes high risk for the market. In various cases, I have seen that these investors do not even have the financial knowledge to invest in which companies or not.
In most cases, they chase after rumors or follow players’ traps. They don’t even hesitate to buy junk stocks. The shares were bought at high prices, and when the price fell, they blamed the regulators and the government, which is completely unacceptable. As a result, I think it will take a long time to break the straightjacket of investors and face reality.
Even if the same investor invests in a term deposit system in a commercial bank for a year or two, he is satisfied with an interest rate of 5 to 6%. Unfortunately, when investing in the context of the financial markets, expectations are sky high, and even a 20-30% return, which is very lucrative if you are a rational investor, does not meet their needs.
As an investor, you have to be rational. As there are more irrational investors in the market, the risk increases and as a result of past bitter experiences, many investors lose their capital and go broke. The blame ultimately falls on our market because no one goes far enough to figure out how you would have lost your hardest money.
As a new investor, this negative feedback will be ringing in your ears. From 1996 to 2010, the blame game continued. As far as I am concerned, regulators are responsible for creating the platform (market). However, it is not their responsibility to advise you on which instruments to invest in.
DON’T PUT ALL YOUR EGGS IN ONE BASKET
This is the famous Warren Buffet quote that we all know. The exciting part is this: how many people follow this theory while investing in the market?
The investment decision is yours, and the profit and loss are all yours. You need to measure your level of risk and the level of risk you can absorb based on your financial situation. Understanding your risk tolerance allows you to make sound financial decisions.
Investors can apply various models which are risk-adjusted return models. One of them is the financial asset pricing model, which will adjust the expected return for the total risk that a particular investor has taken.
AVOID SYSTEMATIC RISK
Systematic risk, also known as undiversifiable risk, affects the entire market, and we cannot avoid it. For example, during the stock market crash of 2010, there was a systematic risk that investors would not save their investments in diversified portfolios. However, we can avoid unsystematic risk by building a diversified portfolio.
If you want to know the level of systematic risk of a particular security, fund or portfolio, you can look at its beta, which measures the volatility of that investment relative to the overall market. A beta greater than one means the investment has more systematic risk than the market, while a beta less than one means less systematic risk than the market.
A beta of one means the investment has the same systematic risk as the market. For example, an investor looking to invest in high beta stocks generally expects a higher rate of return to compensate for higher systematic risk.
An investor looking to invest in a stock with a lower beta generally expects a lower rate of return to compensate for the lower systematic risk. Therefore, it can be said that investors should apply a risk-adjusted model in order to derive expected returns when investing in capital markets.
STRENGTHENING DUE DILIGENCE
Another risk, especially one that most brokerages face, is that investors tend to be more leveraged when investing in the market. Due to the extreme volatility in the market and by nature there is a high risk of not adjusting the margin loan accordingly when the market goes down. Therefore, when we have a prolonged bear market, investors’ equity depreciates day by day, and later portfolio equity becomes negative, making investors and institutions vulnerable.
Many brokerages don’t even have risk management tools to control high-margin loan exposure. Here institutions should be stricter in implementing rules and regulations, especially the 1999 Margin Rules. Also, we need an updated Margin Rules Policy to align due diligence with the scenario current market.
The author is Head of Internal Control and Compliance at UniCap Securities Limited. He can be contacted at [email protected] Views are personal.