The legendary entrepreneur Warren Buffett once said that the secret sauce for success in investing is to be “fearful when others are greedy, and greedy when others are fearful”.
This statement has reached an almost mythic status, but its basic premise remains sound – sell when others are buying (the ‘gold rush’ syndrome), and buy when others are selling (the classic ‘buy low, sell high’ maxim).
These philosophies can be attuned to risk – that is, the inherent risk in investing in the markets at a particular time, and also the individual’s appetite for risk – will you trade only in safe-haven stocks and foreign currencies, or will you try more speculative plays?
Often, our trading decisions are dictated by conditions beyond our control – a look at the latest investment market news will help us to decide when to buy and when to sell, and equally what to buy and what to sell.
However, even when the signals and indicators are suggesting that you should open or close a position, it’s our own inherent risk appetite that will determine if we do or not – or, at least, what percentage of our equity we are willing to put on the line in a single trade.
What Is Risk Appetite?
By our very nature, human beings are all different.
Some of us are pessimistic, conservative, rational traditionalists. Others are optimistic, liberal, brash, free-spirited individuals happy to take chances.
Those are the extreme ends of the spectrum, of course, and most of us will nip in somewhere in between the margins. However, the truth is that our innate personalities determine how many risks we take in our lives.
You see it on busy intersections all the time. There are those drivers who see a tiny gap in traffic that enables them to pull out onto the road and they take it – acknowledging the risk they are taking. Others – well, many of us – are happy to wait for a slightly less risky opportunity to join the flow of traffic.
When it comes to trading forex and other assets, our risk appetite is defined by whether we are willing to take speculative chances on a currency pair, or whether we want to wait a bit longer for all of the signals and technical indicators to scream buy/sell – at which point, some of our profit margins may have already gone to more daring investors.
It should be said that the market’s risk appetite can rise or fall depending on conditions. When things are going well, even more, conservative traders loosen the purse strings and more readily open positions. In a bear market, the more cavalier traders may turn their attention to steadier investments such as gold or strong currencies such as USD/JPY.
When To Be More Risk-Averse
Often, these wider market sentiments determine when we should be more or less risk-averse.
When things are going well, it creates feelings of confidence and bullishness that our next trade simply cannot fail – look at all of the money floodings into the market!
That’s fine, in principle, but the issue is that some traders – shorn of the consequences of risk in their own minds – start to take risks on volatile currency pairs and assets such as cryptocurrencies, with damaging results when the market retracts.
True to Buffett’s words, you can actually be more risk-averse when the market is performing well, and still profit without taking any unnecessary chances.
When To Be Less Risk-Averse
It’s always interesting to see what happens to the markets when there is major geopolitical and economic instability – the Russia-Ukraine conflict is, naturally, a source of much fear for investors.
The numbers speak for themselves – just watch how the stock market and the value of forex pairs crumble during uncertainty, and how the value of gold and safe-haven assets (and, in this particular case, commodities such as oil) increase.
It’s clear that fear has set into the market, and even the most risk-averse traders and investors pull their money out of their positions at these times.
The irony, of course, is that being fearful in times of uncertainty goes against Buffett’s edict of profitable trading. So, maybe we need to overcome our basic instincts and increase our appetite for risk in times of market volatility – this may seem completely counter-intuitive, but perhaps helps to explain the personal journey that we have to go on in order to become successful forex traders.
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Going against the grain does not come naturally to many of us, but being risk-averse in boom times – and ‘risk hungry’ during a downturn – can be a winning strategy. One of the finest investors of all time has taught us that.