The hungriest man in history, a Frenchman called Tarrare, still perplexes experts to this day. Born in 1772, this man with a medical anomaly had an insatiable appetite, which forced him into a miserable life. One could assume that a trader with an insatiable risk appetite would be equally unhappy.
Each person naturally has a different propensity for risk. When you look at risk from a trader’s perspective, you also need to factor in your time horizon, capital, lifestyle, and many other variables. This article will help you figure it out.
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Types of risk appetite
There are three main categories that your risk appetite can fall into.
1. Aggressive
Most aggressive traders are focused on short-term profits; this dictates their asset allocation. These traders have a high risk appetite and are after higher-than-average gains.
Compared to other market players, they have an over-optimistic approach towards their trades, and their capital preservation can sometimes take a back seat. But they don’t mind taking a calculated risk.
2. Moderate
These traders are somewhere in between two camps. With some positions, they take a more aggressive approach; with other ones, they are unwilling to risk a loss. Some would say that it’s the most balanced approach.
Such a portfolio can have a customized composition—for example, 40% aggressive and 60% conservative, 50/50, or something else.
3. Conservative
This trader either wants to preserve their capital or keep their assets on the market over a long enough time period. They only consider stable and low-risk investment options, which historically generate fairly low rates of return but don’t experience wild swings in value.
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Questions to determine your risk tolerance
These questions should be on every trader’s risk tolerance questionnaire:
- What are your goals? Do you want to gain financial independence, pay for education, save for retirement, or do something else?
- How much capital do you have? Will you increase your trading capital each month? How is it going to change in the future?
- What percentage of your capital can you afford to lose?
- When do you plan on using the returns? Can you leave your assets for years? How many years will you be making withdrawals from your account?
- Do you have non-invested savings? How much will you contribute to your savings going further?
- How often do you want to track your investments? Day-to-day, week-to-week, or semi-regularly?
- How would you react if you lost 20% of your portfolio? What if you lost it overnight?
- What’s more important to you: maximizing your returns or avoiding losses?
- How do you feel about market fluctuations?
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Factors that affect your risk appetite
After determining your comfort level with uncertainty, you should consider these factors:
- Age: Younger traders can usually take on bigger risks than older individuals because they have more time to make up for losses.
- Income: If you have a higher capital base and a regular income, you can afford a bigger risk.
- Timeline: If you need a certain sum of capital in twenty years, you can be more conservative than a person with a five-year time horizon.
- Portfolio size: The bigger the portfolio value, the more risk it can take. If one asset loses value, the percentage drop will be lower for a larger portfolio.
- Family: Consider the number of earning members and dependents in your family. This will affect how much spare capital you have, thus affecting your trading capacity.
- Experience: Beginner traders should be cautious with their trades and keep their trade size to a minimum.
Translating risk appetite into a trading strategy
The level of acceptable risk is one of the most important factors when choosing a trading strategy that suits your needs and requirements. People with a higher risk appetite can consider day trading or scaling; more conservative traders can opt for position or trend trading.
If you know your risk appetite, you will be in a better position to pick the right trades. Along with risk, you should consider your personality type, level of discipline, and availability.
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