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How do I compare risk and return?
Loss, volatility, drawdown, diversification and the limits of compact risk measures.
- 01Risk & returns · beginnerRead guide
What does volatility actually mean?
Volatility describes how widely and quickly prices move, not whether an investment is good or bad.
- 02Risk & returns · beginnerRead guide
What is diversification?
Diversification spreads exposure so that one company, sector or risk does not decide the whole result.
- 03Risk & returns · beginnerRead guide
What does investment risk mean?
Investment risk is the possibility that outcomes differ from what is needed or expected, including permanent loss, shortfall, illiquidity and uncomfortable variation. No single number captures every form.
- 04Risk & returns · beginnerRead guide
Investment returns
Investment return is the change in value over a period, including relevant income and costs under a stated convention. The period, cash flows and currency determine the calculation.
- 05Risk & returns · intermediateRead guide
Expected value
Expected value is the probability-weighted average of possible outcomes under a model. It describes the long-run centre of that model, not what must happen next.
- 06Risk & returns · beginnerRead guide
Risk and reward
Risk and reward describe the harmful and beneficial outcomes attached to a choice. A payoff ratio alone is incomplete because probability, frequency, path and estimation error also matter.
- 07Risk & returns · beginnerRead guide
Drawdowns
A drawdown is the decline from a previous peak to a later value before a new peak is reached. It describes experienced loss from the high-water mark, not return from the original start.
- 08Risk & returns · intermediateRead guide
Maximum drawdown
Maximum drawdown is the largest observed peak-to-trough percentage decline in a defined series and period. It is a single worst historical episode under that measurement.
- 09Risk & returns · intermediateRead guide
Correlation in a portfolio
Correlation describes the direction and strength of linear co-movement between two return series. It ranges from minus one to plus one under a defined sample.
- 10Risk & returns · intermediateRead guide
Beta
Beta estimates how an asset's returns have moved with a chosen market benchmark under a linear model. A beta above one indicates greater fitted sensitivity, not a guaranteed future multiple.
- 11Risk & returns · intermediateRead guide
Standard deviation
Standard deviation measures how widely observations spread around their mean under a defined sample. For returns, it is commonly used as a volatility measure.
- 12Risk & returns · advancedRead guide
The Sharpe ratio
The Sharpe ratio divides average excess return by return volatility. It summarises reward per unit of measured variability under strong assumptions and a selected period.
- 13Risk & returns · intermediateRead guide
Downside risk
Downside risk focuses on outcomes below a target, threshold or zero rather than treating all variation equally. Its meaning depends on the chosen boundary and measure.
- 14Risk & returns · beginnerRead guide
Concentration risk
Concentration risk is dependence on a small number of holdings, factors, sectors, regions or counterparties. It can be hidden even when a portfolio contains many lines.
- 15Risk & returns · intermediateRead guide
Sequence-of-returns risk
Sequence-of-returns risk is the effect of return order when money is added or withdrawn. The same average returns can produce different ending wealth when cash flows interact with losses.
- 16Risk & returns · intermediateRead guide
Currency risk
Currency risk is the effect of exchange-rate changes on assets, liabilities or cash flows measured in another currency. Local asset return and home-currency return can differ sharply.
- 17Risk & returns · intermediateRead guide
Interest-rate risk
Interest-rate risk is sensitivity to changes in market rates and discount rates. Fixed-rate bonds, indebted companies and long-dated cash flows can be especially affected.
- 18Risk & returns · beginnerRead guide
Credit risk
Credit risk is the possibility that a borrower or counterparty fails to make promised payments in full and on time. Loss also depends on exposure and recovery after default.
- 19Risk & returns · beginnerRead guide
Inflation risk
Inflation risk is the possibility that rising prices reduce the purchasing power of investment income or capital. Fixed nominal payments are especially exposed over long periods.
- 20Risk & returns · intermediateRead guide
Liquidity risk
Liquidity risk is the chance that an asset cannot be sold, funded or valued promptly at a reasonable price when needed. It often appears most sharply during stress.
- 21Risk & returns · intermediateRead guide
Leverage
Leverage uses borrowing or derivatives so gains and losses apply to exposure larger than the capital committed. It magnifies sensitivity and can create forced action.
- 22Risk & returns · advancedRead guide
Trading on margin
Margin trading uses broker credit and collateral to hold positions larger than available cash. Equity must remain above maintenance requirements or positions can be closed.
- 23Risk & returns · intermediateRead guide
Position sizing
Position sizing decides how much capital or risk to allocate to one exposure. It shapes portfolio damage when the thesis, price path or execution goes wrong.
- 24Risk & returns · beginnerRead guide
Risk capacity
Risk capacity is the financial ability to absorb loss or uncertainty without failing important obligations. It depends on resources, liabilities, horizon and flexibility rather than confidence.