5 Risk Metrics You Should Know Before Trading
How much risk are you really taking?
Risk is a challenging subject in the trading and investment world. Depending on who you ask, it can mean a variety of different things. Some consider risk synonymous with volatility, i.e. the more an asset’s price moves, the riskier it is. Others look at it as the probability of losing money. Still others define it as the inherent uncertainty that exists in the world.
Moreover, it’s impossible to measure precisely; the best we can do is get a rough feel for our the amount of risk we’re taking on.
To do this, we’ll rely on a number of metrics and describe their pros and cons. Each of these captures a different facet of risk that you face, and each is incomplete on its own. Good traders are going to look at all of these metrics — and maybe more — before implementing a strategy.
Sharpe Ratio
This is the classic risk metric that anyone who’s getting into trading is going to hear about at some point or another. The Sharpe Ratio is defined as the returns from a strategy minus the risk-free rate of return and divided by the standard deviation of returns.
It is designed to gauge the excess returns achieved by a strategy by comparing it to a risk-free asset (more on this concept…
