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11.06.2020
What tools are considered high-risk, and why traders choose them

Modern investors have a wide choice of instruments: from classic stocks and bonds to cryptocurrency and IPO. However, there are two main interdependent criteria remain when choosing them: risk and profitability.

According to the level of risk, all investment instruments can be divided into 3 groups: high-risk, medium-risk and low-risk. Risk in this case means a high probability of not returning the invested funds or getting substantially less compared to the estimated or promised profit.

At this point, an uninformed investor may have a logical question: why invest in high-risk instruments, if there is a chance to make a profit without risking anything? We will try to answer it, but first let’s take a look at real examples

TYPES OF HIGH-RISK INSTRUMENTS

High-risk instruments, in fact, include any assets that promise an extremely high (from 30 or more) percentage of income in the shortest possible time.

Most often they include:

·  Venture capital investments – financing in new, little-known, but potentially profitable projects for the further sale of own shares in case of their success. A typical example is startups promoting an innovative idea, which, in theory, can succeed. It is very difficult or even impossible to accurately assess the chances of success is extremely difficult, therefore, the level of risk of not receiving the expected return on invested funds remains high.

·  PAMM accounts – participation in group investment managed by a involved trader. The degree of risk here depends on the professionalism of the PAMM-account manager and the decisions made by him, which investors cannot evaluate and influence. Accordingly, in case of failure, losses are incurred by all participants, including the trader.

·  Hedge funds – another type of group investment, implying the transfer of funds to a separate company (hedge fund), which will use them to invest in various types of assets for a small percentage of their value or level of profit. On the one hand, this makes it possible for a private investor to take part in transactions requiring very large investments and promising high returns, on the other hand, the activities of such organizations are not regulated by the state.

·  Stocks – investments in stocks are also considered high-risk, but only partly, since you can find on the stock exchange both the assets of world giants (for example, Apple or Facebook), which steadily rise in price from year to year, and small companies that can quickly go bankrupt when they have internal or external problems. Certain experience and instincts acquired directly during exchange trading are required to distinguish high-risk stocks from low-risk assets.

WHY DO TRADERS CHOOSE THEM?

As already noted in the introduction, the risk is directly related to profitability, and this are interconnected issues, i.e. the higher the risk, the higher the potential profit. Moreover, you can get it with a significantly shorter time than when buying low-risk assets. This feature, the ability to make a lot of money quickly, is the main driver for many investors.

The choice in favor of risky investments is not always conscious. Such decisions are often made by novice traders who trade impulsively and want to receive income from their investments in the shortest possible time. Unfortunately, in the vast majority of cases, such investments result in a complete loss of funds. However, this fact does not mean that high-risk instruments do not have the right to exist.

They are popular among experienced and professional traders and investors. Basically, active traders who conduct aggressive trading and earn on short-term fluctuations in asset prices prefer them.

Also, high-risk instruments with are actively used when creating so-called balanced investment portfolios. In general, they are designed to receive 5-10% of income over a fairly long period – from three to five years, so the number of aggressive investments in them does not exceed 10%.

Thus, despite serious financial risks, such instruments may be profitable if a trader is skilled and know how to handle them, therefore they continue to exist in the market and are in demand.