We have seen the process for the identification of risk in the previous article of the same series. In the current issue, I am going to discuss regarding recognizing of the risk.
For the successful investing, we must have to focus on the generating return with having a proper control on risk. And for the controlling risk, we require to identifying and recognizing the risk.
The risk is always being at a much higher where we are too much optimistic towards the particular scenario and also paying a much higher price for the buying particular asset. But we should focus on When odds turn out against us than how we can able to protect ourselves or get out of such scenario with least damage. So, for the protecting ourselves, we need to avoid paying too high prices and also keep ourselves away from the extreme level of optimistic sentiment.
Click for Video — Auction scene
We always forget the real worth of the assets in the bull phase and start chasing that asset class. Such behavior is dangerous for the health of our wealth. This increases the risk while we are purchasing assets more than its worth.
The market always works in a pendulum and people generally forget the nature of the pendulum. The pendulum always moves towards the both extreme directions.
Whenever pendulum moves towards the bullish extreme, many of us forget that such situations will not stay forever. Many of us forget about the risk which involves during the bull phase. And start taking higher risk for generating higher returns; which invites further huge amount of risk. At bullish sentiment, people generally buy assets at the highest valuations multiple and that invites the risk to the particular asset class. This scenario has a very high chance of getting damage to our wealth compared to generating a higher return.
Reverse to such scenario, whenever the pendulum moves towards extreme bearish phase, then generally people start recognizing the risk and start avoiding to invest in the particular asset class; which take out the risk from that particular asset class. Such scenario is the appropriate time for capturing the opportunities because in such scenario we have very less chance to lose.
Many a time due to bullish sentiment, we think that the risk is very low, we start taking more risky situations, also start taking leverage and from that time risk starts taking its shape. Our behavior towards particular asset class invites risk.
Risk will be only low if we as an investor behave in a careful and wise manner. We cannot eliminate the risk, but we can able to control its effect. We have to analyze risk in every scenario. Risk always has its presence, though we are having a bullish sentiment. And according to me, the risk is much higher while having a bullish sentiment.
At the extreme bullish sentiment, we forget to worry, fear of loss and instead of it, we think about to miss the opportunity. We think that all others will earn the money and we remain without earning money. We start taking much leverage and believe that we are living in a low-risk world.
Click for Video — Bull phase in auction
We have seen in the above video that the person who doesn’t want to purchase a horse for the Rs.5 lakh; same person bought the horse for the Rs.5 lakh due to the influence of the increasing value of the bid for the horse. The person doesn’t want to lose the horse and cannot see others to take that horse.
Read for more detail: The Most Important Thing Illuminated by Howard Marks