How Do You Measure and Manage Risk

Most investment professionals measure risk as a statistical measurement called standard deviation around a mean.

All this really means is if an investment like a common stock has a mean average trending up or down; the standard deviation is the stock fluctuations (up and down) around that average in any different period of time (hour, day, month etc.). These are also sometimes referred to as volatility bands.

There are also volatility measurements of stock indexes such as the VIX that measure volatility of particular markets.

I watch these measurements on a daily basis to determine what action I need to take (if any) to better manage the risk on the investments I choose.

Actions I might take are to use stops (automatic sell orders), although after our recent “flash crash” these need to be used with caution; I might outright sell a security; or I might use short exchange traded funds to hedge the market. On very rare occasions, I might sell a call option on a stock or ETF.

The sole purpose of these actions is to mitigate volatility as much as it can be migrated and sometimes these actions work and sometimes they don’t. But they don’t need to work all of the time in order to achieve my goal of managing risk.