Risk

What Is Risk in Trading and Investing?

In simple terms, risk refers to the chance of losing money or not getting the returns you expect from an investment. It means that what you anticipate earning may not match up with what actually happens — and sometimes, you might end up losing part or all of your investment.

That’s why traders and investors always talk about the risk vs. reward trade-off . Every opportunity comes with some level of uncertainty, and understanding that risk is key to making smart financial decisions.

Risk is a natural part of any investment or trading activity. However, it can be managed using different techniques such as:

• Diversifying investments across asset classes
• Setting stop-loss orders to limit losses
• Only investing money you can afford to lose — often called "risk capital"

Good risk management helps reduce losses and makes long-term trading more predictable and profitable.

Common Types of Risk Traders Face

1. Market Risk (Systematic Risk)

This is the risk that affects the entire market due to broad economic, political, or global events. For example, during the 2008 financial crisis , nearly every stock market around the world dropped sharply after the U.S. housing bubble burst — leading to massive losses for investors everywhere.

You can’t avoid market risk completely because it’s tied to big-picture factors like recessions, wars, or changes in government policy.

2. Liquidity Risk

Liquidity risk is when you struggle to buy or sell an asset quickly without affecting its price — or worse, not being able to find a buyer at all. This is common with small-cap stocks or niche markets that don’t see much trading activity.

For instance, if you own shares in a small company with low volume and suddenly need to sell due to bad news, you might have trouble finding someone to buy your shares fast enough — forcing you to sell at a much lower price than expected.

3. Credit Risk (Default Risk)

Also known as default risk , credit risk comes into play when you invest in bonds or lend money. If the issuer fails to make interest payments or repay the principal, you could lose money.

Take a corporate bond, for example: if the company goes bankrupt, they may stop paying interest or fail to return your initial investment, leaving you with losses.

4. Operational Risk

Operational risk includes losses caused by internal failures — things like technical glitches, human error, or fraud. These risks are especially relevant in high-speed trading environments.

One famous case is the Knight Capital incident in 2012 , where a software malfunction in their automated trading system led to over $440 million in losses within just 45 minutes — ultimately leading to the firm’s downfall.

5. Inflation Risk

Inflation risk is the danger that the returns on your investment won’t keep up with rising prices. In other words, even if your money grows in dollar terms, its real purchasing power might be shrinking.

For example, if you earn 2% annual interest on a bond but inflation is running at 3%, your actual buying power is going down — not up.

6. Currency Risk (Exchange Rate Risk)

Currency risk matters most in forex trading , but it also affects anyone with international investments. It’s the possibility that exchange rate changes will hurt your returns.

Say you're an American investor holding European stocks. If the euro weakens against the dollar , you’ll get fewer dollars when converting your profits back home — even if the stock performed well in local currency.