Introduction
A significant factor that scares financial market investors or traders is the risk of the market. Financial risk is the major concern of businesses, companies, financial institutions, brokers, individuals, and others who are related to it. All want to minimize their market risks and have a stable trading experience.
However, it is not this simple; everyone related to the financial trade has to have a plan and strategy for enhancing their profits and reducing the loss chances. The article discusses the financial risk and its types to provide an overview of the term and how it could be managed for effective trading.
What is Financial Risk?
The possibility of losing money when investing in a market or financial instrument is called the financial risk of the market. The risk could be related to credit, liquidity, or operational risks of the instruments. Traders have to analyze them and accordingly manage the risks for a profitable outcome.
When an investor or a trader is hit by a financial risk, they lose the capital invested in the market. The risk differs for the parties trading, such as the government has monetary policy risk when they are not able to control it, or debt issues, the similar way the corporations have the risk of market failure of their products in the market, etc.
Every party involved in the financial markets or business faces the financial risk of loss. These could be due to various economic, political, social, and macroeconomic reasons. So every sector of the world that involves money has financial risk incorporated. These differ in size and shape but affect individuals or corporations in different ways.
To minimize these financial risks, traders or investors can have management techniques or policies to handle them and have desired profits.
Types of Financial Risks
Financial risks are unexpected events that occur because of certain changes in the market. The risks are considered the priority of the market dealers, and they take precautions to manage them and have stable profits.
These risks could be different types; here, we have them listed and described below for readers’ understanding.
Market Risk
Market risk is because of the price fluctuations in the market; the financial instruments that are invested or traded by the market participants move or keep changing their prices. It is further categorized into directional and non-directional risks.
Directional risk is due to the movement in the price of an asset, its interest rate, etc., whereas non-directional risk is market volatility.
Credit Risk
The credit risk of the market is when one party fails to fulfill its trade obligations towards the other party. It is classified as sovereign risk and settlement risk. The sovereign risk occurs because of difficult foreign exchange policies. In contrast, the settlement risk is when a party makes the payment and another fails to fulfill the obligation.
Liquidity Risk
Liquidity is the availability of trading instruments into cash, so the liquidity risk is the inability to execute transactions in the market. This could be asset liquidity or funding liquidity risk. In asset liquidity risk is insufficient buyers and sellers in the market against the sell and buy orders, respectively.
The funding liquidity is where the asset is not convertible in cash easily.
Operational Risk
The operational risk of the market is when the operation carried out by parties fails. This could be due to mismanagement or technical failures in the trade. It further has two types: fraud and model risks. The fraud risk is because of a lack of control over operations, and the model risk is due to the wrong model of working.
Legal Risk
Legal risk is documents or financial constraints that the market investor or trader has done wrong or forgets to fulfill. These could be lawsuits or documentation etc.
Other than financial risks, the market has the following risks:
Business Risk
The business risks relate to risks of enterprises that they take in order to expand their business or share value and profits.
Non-Business Risk
Non-business risks are the ones that are not under the control of the company. These risks are due to the political and economic changes in the nation, creating imbalances.
Conclusion
Financial risk is the core part of every business or sector that has money involved. Traders can analyze these and try to minimize them for a comfortable trade and make money. The article has explained financial risks and their types for providing a broader prospect of the topic.
In addition, the readers can classify the financial risks and treat them accordingly. They can take the help of brokers such as PrimeFin and other financial service providers for predicting the market movements. The brokers and service providers offer a range of features to forecast the market, such as analysis tools, trading platforms, customer support, trading accounts, etc.
