Hedging IS Cool

One of the most influential stories in human history is the one where knowledge leads to loss of innocence, resulting in the loss of bliss that gives way to fear and anxiety.

In the world of business, there comes a time for every company to experience an external shock that can put them in an existential crisis. As a consequence, there arises a need to become more aware and gain more knowledge about the risks they face. As knowledge is attained, it puts them on a path that could lead to further fear and anxiety down the road, as exemplified in our recent blog post hedging was supposed to be cool.

Before we move on, let's outline the pattern that story follows.

The pattern

1. External shock — a wake-up call to action.
2. The need — awareness grows, and with it, the pressure to do something about it.
3. Project kickoff — the team gets trained, picks their tools, and hits the market with fresh confidence.
4. Reality sets in — the numbers come in, and nobody wants to present them.
5. Interest fades — as senior sponsors lose interest, a junior analyst inherits the program.
6. Back to square one — hedging is abandoned, and the next unfavorable cycle finds them unprepared.

The role of knowledge

Knowing about options, markets and risks can be more dangerous than not knowing, because it can be empowering but also lead to overconfidence and poor decision-making.

The role of experience

Experience in markets and risks is kind of valuable, but not without knowledge. Experience leads to partial knowledge and "muscle memory" which can taint our view of the markets and lead to poor decisions as well.

The role of knowledge and experience combined

Knowledge and experience combined can lead to a more complete understanding of the markets and risks, because theory and practice do complement each other. Are they enough to guarantee success? We need to factor in emotional intelligence and luck as well.

The role of knowledge, experience, emotional intelligence, and luck combined

Knowledge, experience, emotional intelligence, and luck combined could work. Emotional intelligence (of the team) can be increased through team work and collaboration. Luck remains the only unknown factor, one that will never be controlled.

Dealing with luck

There are two kinds of cool. Team work, knowledge, experience are cool. Leads to meaningful conversations and possibly pay rises.

Dealing with luck is another kind of cool, one in which you take the back seat and let it play out.

Incredibly, you can let it play out as a strategy and have an active role in leaving markets alone without getting hurt. It takes proactive thinking, an active imagination, and love of your weekends. A firm decision to look for opportunity and excitement elsewhere.

The roar of the market makes this the most difficult task that a risk manager can face. The difficulty is compounded by the surroundings. If the institution exists in an echo chamber where everyone is researching, learning, and discussing market conditions, it becomes even more difficult to stay detached. Active participation becomes the norm, and it takes just one mistake to re-live our earlier story.

Passive strategy for dealing with risk

1. Measure the risk exposure
2. Set a level of risk tolerance
3. Hedge the rest over a period of time
4. Select only the most appropriate instruments

Putting it all together

• Experience should help you measure risk.
• Knowledge should help you choose the appropriate instruments.
• Emotional intelligence should help you stay on course.
• Luck should play out within your ordered system.