You wake up and measure your risk how? What do you do? What is Wall Street's typical plan for measuring risk? Trend Followers measure risk every day, but what about others?
David Loeper of Financeware offers insight on the concept of risk. However, while we find he presents good food for thought and some very good concepts and lessons, he misses the mark on a key point. Here is an excerpt from his writings:
Getting the most return out of a portfolio for the risk being taken is extremely helpful. The way we measure this risk really is not all that material to most statisticians. Whether it is standard deviation, maximum loss or some other risk measure is not really all that important. A good mathematician can conceptualize these into his or her realm. The generally accepted measure is standard deviation. This is not a particularly difficult concept to grasp, as what it measures is the extent and frequency that individual returns will vary from the average of the returns.
-David Loeper,
Financeware
We disagree with this excerpt. Measuring risk is indeed important. Unfortunately, standard deviation measures volatility, not risk. Standard deviation does not consider the ordering of returns -- this is a huge point. This kind of thinking sounds similar to what drove Long Term Capital Management.
More on risk and volatility - 1.
More on risk and volatility - 2.
More on Long Term Capital Management from The Cato Institute.
