Risk & Psychology
Measuring risk and mastering the biases that drive decisions.
Risk is what investing is really about, and this topic treats it from both the numbers and the mind.
It covers the measures professionals rely on, from volatility and Value at Risk to the Sharpe ratio that scales return against risk taken.
Then it turns to behavioral finance, the biases that quietly wreck returns: loss aversion, herding, and the anchoring that traps investors at the wrong price.
Investing With Purpose pairs the quantitative tools with the psychology because one without the other fails in practice.
The goal is to measure the risk you carry and recognize the patterns in your own decisions before they cost you, which is where most of the damage happens.
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Investment risk is the chance that your actual return will differ from what you expected, including the possibility of…
Value at Risk is a single number that answers one question: over a given horizon, how bad can losses get on a normal…
The Sharpe ratio measures how much return an investment earns per unit of risk, where risk is defined as the volatility…
Loss aversion is the finding that a loss feels roughly two to two-and-a-half times worse than an equivalent gain feels…
Herding is what happens when investors stop acting on their own information and start copying the crowd. It is not…
Anchoring bias is the tendency to rely too heavily on the first number you see when making an estimate. In investing,…
More in Risk & Psychology
Every investment faces two kinds of risk. One affects the whole market and cannot be diversified away. The other is…
Standard deviation is the most widely used single-number summary of investment risk. It tells you how far a fund's…
Variance is the average squared distance between a return and its mean. It is the raw statistical ingredient behind…
A stop loss is a predetermined price at which you exit a position to cap the loss. It is the single most common…
Confirmation bias is the tendency to seek, interpret, and remember information in ways that support what you already…
Recency bias is the tendency to weight recent events more heavily than their long-run statistics justify. In investing,…
The availability heuristic is a mental shortcut where people judge how likely something is by how easily examples come…
Beta is a single number that tells you how much a stock tends to move compared with the broader market. It is the…
Alpha is the portion of an investment's return that cannot be explained by market movement alone. It is the number…
Drawdown is the percentage decline in a portfolio's value from a previous peak to a later trough. Maximum drawdown is…
The Sortino ratio measures risk-adjusted return using only downside volatility in the denominator, on the theory that…
The Calmar ratio compares a strategy's annualised return to its worst peak-to-trough loss. It is a favourite of CTAs,…
The Treynor ratio measures a portfolio's excess return per unit of **systematic** risk, where systematic risk is…
The information ratio measures how much excess return an active manager produces per unit of tracking error against a…
Tracking error measures how much a portfolio's return deviates from its benchmark over time. It is the standard…
Liquidity risk is the risk that you cannot convert an asset into cash, or raise cash to meet an obligation, without a…
Credit risk is the risk that a borrower or contractual counterparty fails to meet its obligations, leaving the lender…
Counterparty risk is the risk that the other side of a financial contract fails to perform before the contract settles.…
A black swan event is a rare, high-impact occurrence that sits outside the expectations of standard models and is…
Risk budgeting is the practice of allocating a portfolio's total risk, not just its capital, across positions, asset…
Prospect theory is the descriptive model of how real people choose between risky options. It replaces the idea that…
Overconfidence bias is the tendency to overestimate your own knowledge, judgement, and ability to predict outcomes. In…
The disposition effect is the well-documented pattern of selling winning positions too early and holding losing ones…
The sunk cost fallacy is the tendency to let unrecoverable past spending drive decisions about the future. In markets…