Finance question?

Question

i have a essay question like the following
a layman's definition of risk is different from the one that has proven useful in finance. how are these definition different and how is the laymen's difinition deficient in the context or evaluation financial assets? how can one estimate the riskiness of a particular asset? how does an asset's riskiness affect its price?

Answer 1

In finance risk is loosely said the variation in return. This can be positive a negative. A layman only sees the negative part of it. His risk is to lose money and a better return than he bargained for is not considered risk.

In finance a portfolio is constructed of more than one asset. By choosing uncorrelated assets risk is diminished. But such optimisation is possible only using the finance definition of risk.

Risk is defined as a standard deviation of returns.

Answer 2

I respectfully submit that all of this fundamental theory of risk is a bunch of baloney. There is always a little bit of sweetness of truth in a lie, or it couldn't be swallowed. Risk as a measure of variance and standard deviation and volatility, are mathematical theories that can only average both sides of the equation and come "close" to defining risk, but it's all still an average of something I want to be specific, and leaves me wanting.

I don't care how much you diversify, you cannot diversify away market risk, or economic risk, or terrorist risk, or greed, fear, and hope risk, for that matter. These theories mean nothing in these instances, except for distorting their "averages."

You cannot diversify a portfolio into a profit during a Downtrend. Okay? Given. So why all the hogwash. Fundamentals don't work for me, obviously.

Allow me to evaluate my risk specifically, when it interests me most, at the point of entry into a Long position. I'm not at risk while I'm out of the market and all of these different theories are being bashed around, expounded on, taught at university, and made Brownie Points for Doctorate degrees, and applauded in the news and books authored by the new Doctorates. Most of the people talking about these theories, have never traded a dime.

So from a trader's perspective, using Technical Analysis, the viewpoint is a little different.

I answered a similar question to this one, explaining the strategy of "Buying the Dips." Why would anyone do that? Because your risk is lower. Here it is.

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Go to Yahoo Finance and click on a chart of the Dow.

The Dow made a Double Bottom on 6/13 and 7/14. As a trader, I buy all Double Bottoms, and sell all Double Tops. That is one way of looking at "Buying the Dips" or selling the rallies. There are two sides to every market, not just the upside.

What nobody else mentioned here, is that you only "Buy the Dips" in an Uptrend. Many people just don't get it, and think that just because a stock goes down, it's a better value. Not true. It can usually go lower first, until it finds significant Support.

If Yahoo.com was a great buy at $130/sh, it must really be a good deal at $60, right? So anyone that bought that Dip lost over half their money, because Yahoo is trading at $25 today.

Same thing with Exxon. All the great brokerage houses were recommending to buy Exxon, from $45 all the way down to $10. And the SEC approved each quarterly filing.

So no, "Buying the Dips" doesn't work in just any situation, as other people here would have you believe. They may think they know what they're talking about, but they're not traders. "Buying the Dips" is a "trading" activity, not an "investing" activity.

Back to the Dow chart. If you connect the lows, beginning on 7/14 to present, you can visualize an Uptrend Line. You can also think of the Uptrend Line as a Support Line. Each time the Dow pulled back (declined) to the Uptrend Line (a dip), would be the time to buy. In fact, each time the Dow touched the Uptrend Line are the lowest risk trades on the chart, aside from the Double Bottom, because a Protective Stop can be placed just on the other side of Support, just a few points away.

Placing a Stop at the time of entry of the trade, means you've made an objective evaluation ahead of time, and defined your risk, rather than waiting to see what happens and trading on emotion, which is almost always unwise.

------------------------ end of "Buy the Dips" ------------------

Okay, now at each point where the Dow approached the Uptrend Line, or made that Double Bottom, your risk is specifically defineable by your Stop placement. Since you want your Protective Stop to be on the other side of Support, and price is sitting right on Support, then you can place the Stop very close. These points of price touching the Support line are the narrowest point for Stop placement, and the narrowest risk.

This "risk" is exactly defined in points and Dollars, and not just some "theory."

Answer 3

here is a start... in finance we view risk and return as going hand in hand. the layman might not see the addition risk when looking for a higher return.