Trading

Education & Tools

Partners

Open Account

All

ANALYSIS

EDUCATION

CRYPTO

COMPANY NEWS

PARTNERS

PROMOTIONS

GLOSSARY

Glossary

Risk assets: Explained

BY TIO Staff

|August 15, 2024

In the world of trading, the term "risk assets" is often thrown around. But what exactly does it mean? In this comprehensive glossary entry, we'll delve deep into the concept of risk assets, exploring their definition, types, characteristics, and their role in a trading portfolio. We'll also discuss the factors that influence their performance and the strategies traders use to manage the risks associated with them.

Understanding risk assets is crucial for any trader, as they form a significant part of most trading portfolios. They can offer high returns, but they also come with a higher level of risk compared to other asset types. This makes them a double-edged sword that can either boost your profits or lead to significant losses. Therefore, a thorough understanding of risk assets is key to successful trading.

Definition of Risk Assets

At the most basic level, risk assets are investments that have a significant degree of price volatility. They are called "risk" assets because their return rates can vary widely, making them more risky than other types of investments. In other words, the price of these assets can change rapidly in a very short time, making it possible for investors to experience significant gains or losses.

Examples of risk assets include stocks, commodities, high-yield bonds, real estate, and foreign currencies. These assets are considered risky because their prices are influenced by a myriad of unpredictable factors, including economic indicators, market sentiment, political events, and even natural disasters.

Stocks as Risk Assets

Stocks are perhaps the most well-known type of risk assets. They represent ownership in a company and come with a claim on part of the company's assets and earnings. However, the price of a stock can fluctuate wildly based on a wide range of factors, including the company's financial health, the state of the economy, and market sentiment.

Despite their volatility, stocks have the potential for high returns, making them a popular choice for risk-tolerant investors. However, they also come with a high level of risk, and investors can lose their entire investment if the company underperforms.

Commodities as Risk Assets

Commodities, such as gold, oil, and agricultural products, are also considered risk assets. Their prices are highly volatile, influenced by factors such as supply and demand, geopolitical events, and changes in the economic landscape.

Investing in commodities can be a good way to diversify a portfolio and hedge against inflation. However, like all risk assets, they come with a high level of risk, and investors can experience significant losses if the market moves against them.

Characteristics of Risk Assets

Risk assets have several common characteristics that set them apart from other types of investments. Understanding these characteristics can help traders make informed decisions about whether to include risk assets in their portfolios.

One of the key characteristics of risk assets is their high level of price volatility. This means that the prices of these assets can change rapidly in a very short time, making it possible for investors to experience significant gains or losses. This high level of volatility is due to the unpredictable nature of the factors that influence the prices of risk assets.

High Potential Returns

Despite their high level of risk, risk assets are popular among traders because of their potential for high returns. For example, stocks have historically provided higher returns than safer assets like bonds or cash. However, the potential for high returns comes with a high level of risk, and there is no guarantee that investors will achieve the returns they expect.

It's also worth noting that the potential for high returns can sometimes lead investors to take on too much risk. This is known as risk-seeking behavior and can lead to significant losses if the market moves against the investor.

Unpredictability

Another key characteristic of risk assets is their unpredictability. The prices of risk assets are influenced by a wide range of factors, many of which are difficult to predict. These can include economic indicators, market sentiment, political events, and even natural disasters.

This unpredictability can make risk assets a challenging investment choice. However, it can also provide opportunities for traders who are able to accurately predict market movements.

Role of Risk Assets in a Trading Portfolio

Risk assets play a crucial role in a trading portfolio. They can provide diversification, act as a hedge against inflation, and offer the potential for high returns. However, they also come with a high level of risk, and traders need to carefully consider their risk tolerance and investment goals before including risk assets in their portfolio.

One of the key benefits of including risk assets in a portfolio is diversification. Because risk assets often move in different directions to safer assets like bonds or cash, they can help to reduce the overall risk of a portfolio. However, it's important to remember that diversification does not guarantee profits or protect against losses.

Diversification

Diversification is a risk management strategy that involves spreading investments across various financial instruments, industries, and other categories to reduce exposure to any one particular asset or risk. A well-diversified portfolio will consist of different types of assets that are unlikely to all move in the same direction at the same time.

When it comes to risk assets, diversification can help to mitigate some of the risks associated with these types of investments. By including a mix of risk assets in a portfolio, traders can protect themselves against the possibility of a single asset or group of assets performing poorly.

Hedging Against Inflation

Another role of risk assets in a trading portfolio is to act as a hedge against inflation. Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.

Some risk assets, such as commodities, can provide a hedge against inflation. This is because the prices of these assets often rise when inflation is high. By including these assets in a portfolio, traders can protect themselves against the eroding effects of inflation on their purchasing power.

Factors Influencing the Performance of Risk Assets

The performance of risk assets is influenced by a wide range of factors. These can include economic indicators, market sentiment, political events, and even natural disasters. Understanding these factors can help traders make informed decisions about when to buy or sell risk assets.

One of the key factors that influences the performance of risk assets is the state of the economy. In general, risk assets tend to perform well when the economy is growing and poorly when the economy is in a downturn. This is because a growing economy can lead to increased corporate profits, which can boost the prices of risk assets like stocks.

Economic Indicators

Economic indicators are statistical measurements that reflect the overall health of an economy. They can include measures like GDP growth, unemployment rates, inflation rates, and consumer confidence indexes. These indicators can have a significant impact on the performance of risk assets.

For example, high GDP growth can signal a strong economy, which can boost the prices of risk assets. On the other hand, high unemployment rates can signal a weak economy, which can lead to lower prices for risk assets.

Market Sentiment

Market sentiment, also known as investor sentiment, is the overall attitude of investors toward a particular security or financial market. It is the tone of the market, or the crowd psychology, as revealed through the activity and price movement of the securities traded in that market.

Positive market sentiment can lead to higher prices for risk assets, while negative market sentiment can lead to lower prices. Traders can gauge market sentiment through various indicators, including price trends, volume trends, and market volatility.

Strategies for Managing the Risks of Risk Assets

While risk assets can offer high returns, they also come with a high level of risk. Therefore, it's crucial for traders to have strategies in place to manage these risks. These strategies can include diversification, hedging, and the use of stop loss orders.

Diversification is a key strategy for managing the risks of risk assets. By spreading investments across a variety of different assets, traders can protect themselves against the possibility of a single asset or group of assets performing poorly.

Hedging

Hedging is a strategy that involves taking an offsetting position in a related security. This can help to protect against losses in the event that the price of the risk asset falls. For example, a trader who owns a stock might buy a put option on the same stock. If the price of the stock falls, the trader can exercise the option and sell the stock at the strike price, limiting their losses.

However, hedging is not without its risks. It can be expensive, and there is no guarantee that it will protect against losses. Therefore, traders need to carefully consider their risk tolerance and investment goals before using hedging strategies.

Use of Stop Loss Orders

Stop loss orders are a type of order that automatically sell a security when it reaches a certain price. They can be used to limit losses on risk assets. For example, a trader might set a stop loss order at a price 10% below the current price of a stock. If the price of the stock falls by 10%, the stop loss order will automatically sell the stock, limiting the trader's losses.

However, stop loss orders are not foolproof. In fast-moving markets, the price of the security may fall so quickly that the stop loss order is executed at a lower price than expected. Therefore, traders need to carefully monitor their investments and adjust their stop loss orders as necessary.

Conclusion

Risk assets play a crucial role in the world of trading. They offer the potential for high returns, but they also come with a high level of risk. Understanding the characteristics of risk assets, the factors that influence their performance, and the strategies for managing their risks is key to successful trading.

While risk assets can be a valuable addition to a trading portfolio, they are not suitable for everyone. Traders need to carefully consider their risk tolerance and investment goals before deciding to invest in risk assets. With careful planning and risk management, however, risk assets can provide a powerful tool for achieving trading success.

Start Trading Risk Assets with TIOmarkets

Ready to put your knowledge of risk assets into action? Join TIOmarkets, the top-rated forex broker, and access a world of trading opportunities. With over 170,000 accounts opened across more than 170 countries, our platform offers the ability to trade 300+ instruments across 5 markets, including Forex, indices, stocks, commodities, and futures, all with low fees. Enhance your trading skills with our comprehensive educational resources and step-by-step guides. Create a Trading Account today and start your journey towards trading success.

Risk disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Never deposit more than you are prepared to lose. Professional client’s losses can exceed their deposit. Please see our risk warning policy and seek independent professional advice if you do not fully understand. This information is not directed or intended for distribution to or use by residents of certain countries/jurisdictions including, but not limited to, USA & OFAC. The Company holds the right to alter the aforementioned list of countries at its own discretion.

Join us on social media

image-959fe1934afa64985bb67e820d8fc8930405af25-800x800-png

TIO Staff

Behind every blog post lies the combined experience of the people working at TIOmarkets. We are a team of dedicated industry professionals and financial markets enthusiasts committed to providing you with trading education and financial markets commentary. Our goal is to help empower you with the knowledge you need to trade in the markets effectively.