Investment Risk Management
There are several main methods of investment risk management:
- Diversification. Diversification is the easiest and most of the times the cheapest way to reduce risk level of the investment portfolio. However, the power of diversification is limited to a market risk. The best you can do is to widen your investment market and use more asset classes.
- Hedging. Hedging is usage of derivative instruments as futures, forward, options and swaps to control possible risks. However, such hedging has additional costs: whether you have to surrender your potential profits or pay additional costs. Hedging mostly is used by financial institutions for which the stability of investments is the main priority.
- Fundamental risk management. Fundamental risk management is similar to diversification but investments must be spread between anti correlating assets. This means an investor have to use investments that are moving in different directions under some market conditions. A good example of it might be transportation company’s shares and oil extraction company’s shares. If oil prices are growing it makes suffer transportation company’s results, but oil company under such circumstances will do better.