Wednesday, July 4, 2012

Risk, Exposure, and Probability

From the book What I Learned Losing A Million Dollars by Jim Paul and Brendan Moynihan:

"The definition of risk is to expose to the chance or possibility of loss. Most people erroneously try to assign a numerical value to that chance, which simply confuses risk with probability. In the markets we are talking about unique, non-repeatable events so we can't assign a frequency probability to their occurrence. In statistical terminology, such events are categorized under case probability, not class probability. This means the probability of market events is not open to any kind of numerical evaluation. All you can actually determine is the amount of your exposure as opposed to the probability that the market will, or will not, go to a certain price. Therefore, all you can do is manage your exposure and losses, not predict profits."