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Risk Management

Allowing fear or greed to enter our risk management allows emotions to be the arbiter of incoming information that creates the framework for making subsequent decisions: a wrong premise as both fear and greed are emotions; one cannot postulate a balancing tug-of-war between them. Risk management needs to be derived from relevant sensory input. For example, a risk-adjusted crossing a street requires that we use our sense of vision and hearing; even the best mathematical formula will not be helpful if we don’t have theses senses because we exit risk and enter uncertainty which is not quantifiable. Furthermore, in this example, allowing our emotions (fear or greed) to dominate the decision process is an invitation to disaster. The difference between crossing a street and financial investments is simply a matter of learning that takes place through feedback: an immediate one with crossing the street, and a delayed one in the financial/economic marketplace.

Another important issue that comes into play in the risk assessment of the financial markets is trust. And, the degree of trust depends on where the economy/society is within its long-term cycles. For example, as the society/economy expands its credit, it dilutes the existence of trust (the cycle begins with: trust but verify and ends with no need to verify). Here we have multiplying variables: an analyst may use relevant sensory perception in his risk assessment or he may be primarily affected by his emotions (fear and greed). The subsequent users of that information are facing a geometrically-expanding complexity to solve: What is the level of trust between/among us? What is the investor’s dominant thought process, etc.? System’s complexity is changing into complicatedness, a change from facing risk to facing uncertainty. As Tiger Woods was quoted last year in the “Best Advice I ever got: Keep it simple.”

Disclosure: none