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Risk analysis is a process of assessing and evaluating potential risks and their impact on an organization, project, or decision-making.
The objective of this article is to review latest applications of Financial Risk Management (FRM) in stock (algorithmic) trading and investments.
Algorithmic Trading (AT) is when you use SaaS products to open and close trades according to set rules such as points of price movement in an underlying market. Once the current market conditions match any predetermined criteria, trading algorithms (algos) can execute a buy or sell order on your behalf.
In principle, AT can generate profits at a speed and frequency that is impossible for a human trader. To earn profits at an unattainable frequency for a human trader, algorithms are used to automate trading.
In this overview, we look at the key trends, case examples and best industry practices that set to accelerate the AT market growth in 2023 and beyond. Factors such as the increasing adoption of ML/AI, real-time data analytics, interactive visualizations, and the rising demand for automated trading systems substantiate the rapid AT industry growth in 3 key regions such as North America, Europe, and Asia.
Financial Risk Management (FRM)
Financial Risk (FR) refers to the likelihood of losing money on a business or investment decision. Risks associated with finances can result in capital losses for individuals and businesses.
There are several financial risks, such as market, credit, liquidity, and operational risks, as shown below.
Market risk can be classified as Directional Risk and Non-Directional Risk. Directional risk is caused due to movement in stock price, interest rates and more. Non-Directional risk, on the other hand, can be volatility risks.
Credit risk can be classified into Sovereign Risk and Settlement Risk. Sovereign risk usually arises due to difficult foreign exchange policies. Settlement risk, on the other hand, arises when one party makes the payment while the other party fails to fulfill the obligations.
Liquidity risk can be classified into Asset Liquidity Risk and Funding Liquidity Risk. Asset Liquidity risk arises either due to insufficient buyers or insufficient sellers against sell orders and buys orders respectively.
Operational risk can be classified into Fraud Risk and Model Risk. Fraud risk arises due to the lack of controls and Model risk arises due to incorrect model application.
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