Why Measure Risk?
Everyone talks about returns, but risk is what keeps you in the game. A strategy that makes 20% a year sounds great — until you find out it sometimes loses 50% in a bad month. If you can't handle that kind of drop, you'll panic and sell at the worst time.
Risk metrics give you numbers you can use to compare strategies, size your trades, and sleep well at night.
Value at Risk (VaR)
VaR answers one simple question: "What's the most I'm likely to lose in a day?" For example, if your 95% VaR is $500, that means there's only a 5% chance you'll lose more than $500 today.
This helps with position sizing. If you don't want to lose more than $1,000 in a day, VaR tells you how many shares you can safely hold. Keep in mind that VaR covers normal days — rare extreme events can be worse.
Sharpe Ratio and Sortino Ratio
The Sharpe ratio measures how much return you get for each unit of risk. A Sharpe above 1.0 is good. Above 2.0 is excellent. Above 3.0 is rare.
The Sortino ratio is similar but smarter. It only counts downside risk — because going up a lot isn't really "risky," right? A stock that jumps 10% in a day isn't a problem. The Sortino ratio ignores that kind of movement and focuses only on the bad kind of risk.
Maximum Drawdown
This is the biggest drop from a high point to a low point in your portfolio's history. If your portfolio hit $100,000 and then fell to $70,000 before recovering, your max drawdown is 30%.
Ask yourself: "Could I handle a 30% drop without selling?" If the answer is no, you need a safer strategy. Drawdown tells you the worst pain you should be prepared for.
Beta
Beta measures how much a stock moves compared to the overall market. A beta of 1.0 means it moves about the same as the market. A beta of 1.5 means it moves 50% more — bigger gains in good times, bigger losses in bad times. A beta of 0.5 means it's calmer than the market.
If you want a calm portfolio, pick stocks with lower betas. If you want more excitement (and more risk), go with higher betas.