Proper risk management is one of the most essential skills of any successful trader or investor in the financial market. In reality, the financial market can be very fast-paced and unstable and even the smallest perceived losses can have a very significant impact on an investor’s portfolio.
Despite the recent adoption of technologies such as algorithms, models, and software in financial markets trading, the human element (usually the trader) and his/her mindset are very important in risk management and financial trading.
Risk management usually involves processes like identifying potential risks, assessing such risks, and minimizing them in such a way that potential losses are minimized while achieving investment goals. Risk culture or Risk management in brokerage firms is very important to ensure responsible trading practices whilst creating a conducive and successful environment.
Why Does the Human Element Matter in Risk Management
Human judgment and intuition are key elements in making trading decisions. Alongside the use of technical tools, fundamental analysis, algorithms, models, and so on, experienced traders still rely on their gut feeling to make trading decisions. Therefore, the human element of risk management cannot be overlooked or glossed over. Here are a few important reasons why the human element is important in risk management:
? Contextual Interpretation: To be quite honest, algorithms and quantitative models are great, they improve the trading process efficiency. However, these models and algorithms often rely primarily on historical data and may not be able to analyze additional context such as unforeseen events and market dynamics. Consequently, the role of humans is highlighted. Seasoned investors are experienced in interpreting data in the right context while considering other factors like unforeseen circumstances to make better-informed decisions.
? Ethical Considerations: Ethics is a very important aspect of risk management. Experienced traders assess the impact of trading decisions on various stakeholders and make conscious efforts to make decisions that align with ethical and regulatory requirements.
? Adaptability: Humans are better equipped to deal with the constantly evolving nature of the financial markets. Unstable markets require adaptable risk management strategies such as adjusting risk parameters, identifying emerging risks, and most times, making real-time decisions. These strategies often rely on the trader’s judgment and intuition.
? Communication and Collaboration: Communication and collaboration skills are top skills for effective risk management in brokerage businesses. Although technology aids in faster communication and collaboration, humans are still better equipped for such tasks in organizations.
Benefits of a Risk-aware Culture in Brokerages
Brokerage firms who are deeply invested in maintaining a risk-aware culture enjoy the following benefits:
? Lesser losses: Brokerage firms that are very active in identifying and managing risks will always be more likely to minimize potential losses and protect their clients’ assets.
? Better decision-making: Employees who are equipped with the necessary risk-cautious knowledge and tools make more responsible and better-informed trading decisions.
? Better reputation: A risk-aware organizational culture breeds employees who always make responsible trading decisions, therefore increasing trust and confidence in employees and the firm. The combination of investors’ confidence in the firm, and the minimization of losses the firm benefits from being risk-aware helps to build a good reputation for the brokerage.
? Compliance: A risk-aware organization is a compliant organization. A firm that heavily invests in understanding and minimizing risks will adhere strictly to regulatory requirements to minimize the risks of regulatory violations.
Building a Risk-aware Culture in Your Organization
As earlier mentioned, the benefits of a risk-aware culture in a brokerage cannot be overemphasized. However, creating a risk-aware culture is beyond implementing risk management policies, the understanding and employment of risk management must be embedded in the organization’s values and practices. Some of the key strategies to achieve this are:
? Leadership: Senior management should set the tone of risk awareness in the firm by leading by example. This will encourage others to emulate such practices.
? Training and Development: Like with every other habit, risk awareness must be learnt. Management should organize training, workshops, and seminars targeted at understanding the importance of risk awareness in the firm.
? Open Communication: Openly addressing risk-related matters is important to foster risk-awareness. Management should be comfortable discussing risk management strategies and policies, risk assessments, and other related matters with employees. This creates awareness about risk and demonstrates the importance of prioritizing risk-awareness.
? Incentives: Management should be open to rewarding employees who are risk-aware and prioritize risk mitigation in their daily dealings. This teaches the importance of risk-awareness and encourages responsible decision-making.
? Psychological Safety: Brokerages that are interested in building a risk-aware culture must also create an environment that encourages employees to speak up and identify potential risks in their dealings without the fear of retribution or being blamed. If employees feel psychologically safe enough to open up when they suspect any form of risks, they become encouraged to identify more risks and contribute to the overall risk management efforts of the organization.