Risk Management and Market Analytics


Risk Management is the creation of mechanisms, policies and processes that reduce market and trading risk, while Market Analytics is the collecting, filtering and interpreting of market data to detect trends, correlations and support risk models. The goal is for the market analytics to help build models of understanding for risk mitigation policies. You may say that analytics are the 'eyes and ears', the perceptual apparatus, while the processes of risk management are the implementation and actions. The purpose is to identify and control risks to capital, and is a requirement of most institutional investors.

Risk controls go beyond trading strategies and focus on mitigating 'black swan' types of events, entry errors during trades, electronic market instabilities, or rogue trading. This can only be achieved by risk management finding abnormal events both in trading activity and market conditions. In addition, automation has ushered in a new era of computer based trading and algorithm risks, so these events extend to computational instabilities and high frequency trading collisions.

Value at Risk

The Value at Risk or VaR estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. This term is used as part of the feedback mechanism for additional investments. Portfolio risk is constantly monitored by such metrics so that additional investments are capped within an acceptable risk profile. Metrics such as VaR are critical to professional trading operations and hedge funds. The professional operation can not afford to wait for longer term market corrections to resolve short term trading events. 

Retail Investor Risk Management

Most retail investors purchase index or mixed asset funds and hold for longer durations, as time is on the retail investors side. However, the retail investor is making a risk trade-off where their risk profile locks them into decade long commitments. Many retail investors also fail to hold during the gut-wrenching turns of the market and so what is a personal pledge at the start of an investment turns into poor investment management when under pressure. 

Advantages of Professional Fund Risk Management

Funds must manage risk to maintain customer loyalty and performance. This risk management may be a combination of controls, some outside the trading operation, others as part of trade construction as in long and short positions. The level of focus and success of well run funds rely on a combination of these controls. Well run funds have the staff to manage risk using both electronic controls and human intervention with long and short trading hedges. This helps mitigate normal market pressures and risks.