Risk management is one of the most important things an investor needs to be able to understand to achieve profit. Along with understanding the cyclical nature of the markets and where they stand at present, risk management could be said to be the most important factor, according to Howard Marks, co-founder and co-chair of Oaktree Capital Management and legendary investor.
Marks’ latest book looks at the nature of financial market cycles, running with the idea that we can never know exactly what is going to happen but we can know where we are in terms of the cycle.
Thibaut de Roux has almost three decades of experience to date of working in risk management, so he will undoubtedly understand its importance. Understanding the cycle, according the Marks, is key to getting the odds on your side and properly managing risk to make consistent profit.
According to Howard Marks, there is no particular skill involved in simply making money in the financial markets. The markets do well for the majority of the time, making it easier to make money. When the markets are doing well, it is therefore easy for some to make more than the average amount of profit. The trick, states Marks, is to be able to maintain a profit by controlling risk, rather than simply by taking on more risk in the short-term.
The level of risk changes depending on where the markets are at in their cycle, which makes understanding the cycle paramount for the savvy investor. When the market is low in the cycle, investments can be made with relatively lower risk and potentially higher profits. When the market is high in the cycle, the reverse is true, making each investment far riskier.
Understanding Market Cycles
Fluctuations in prices in the short-term are always going to occur within financial markets no matter what the conditions. However, there are recognisable patterns to the stock market that occur over the long-term and can be attributed to various causes.
Technical analysis of these markets can therefore be advised by these predicated patterns. There are never any guarantees, but many stock market analysts are able to make relatively accurate predictions a lot of the time by using certain analytical tools based on observations of stock market cycles.
Well-known patterns or cycles that often affect stock market prices and volatility include the lunar cycle, the United States four-year cycle of presidential elections, the 60-year Kondratiev cycles, the 17.6-year stock market cycle, and annual seasonality which includes the July effect, the January effect, the Halloween indicator and Sell in May.
Risk Less to Earn More
A successful, consistent investment strategy requires the investor to be able to minimise their exposure to risk while still making a high return. Investors lacking a proper plan for risk management may find that they have periods of riding high, but one bad investment can easily bring the whole house of cards crashing down. Risk management can bring financial security, ensuring that any losses incurred do not exceed an acceptable level.
Howard Marks states that investors seeking to outperform others need to be prepared to do something different, which involves staying out of the emotional swings of the markets and instead recognising and dealing with risk as and when it arises.