What Is a Rio Trade?
The term Rio trade refers to a high-risk financial market transaction that a trader makes in order to recover previous losses. The term originated from the idea that a desperate trader would buy a ticket to Rio de Janeiro and hop on a plane to escape creditors, regulators, or legal authorities. As noted, a Rio trade is generally a higher-risk trade than a trader would normally make since it is executed under dire circumstances.
- A Rio trade attempts to recover losses stemming from previous trades by making increasingly riskier trades.
- The term originated from the idea that a desperate trader would buy a ticket to Rio de Janeiro and hop on a plane to escape creditors, regulators, or legal authorities.
- Many Rio trades are made by speculators who already take high risks in the hope of achieving high returns or break-even after incurring losses.
How a Rio Trade Works
The financial world is full of risks and no one is immune to them. The term risk refers to any chance that a trade or another type of investment's outcome will be different from what's originally expected. Every individual has a specific risk profile. This is an evaluation of how much risk someone can tolerate and is willing to accept.
The younger you are, the more risk you're able to tolerate. But if you're older, you'll want to look at investments that will preserve your capital.
The level of risk that comes with many investments and trading strategies depends on the expertise of the person who makes the investment decision. Some traders, like speculators, take on more risk than others. Speculators intentionally take high risks in the hope of achieving high returns. Speculators are active traders who employ hedging strategies to mitigate their risks.
Some of these high-risk trades may pay off, making these traders money in the end. But in some cases, the trades don't always pan out the way traders hope and they end up racking up large losses. Virtually all these traders are male. Those who are undisciplined may be addled by testosterone and may try to double down on the losing bet or try another high-risk trade to make up for losses incurred in the previous one.
This trade essentially becomes an all-or-nothing trade. If a trader profits from the move, they can go back to work with their head held up high. But a trader who loses likely won't feel that way. Afraid of the humiliation or of being shown the door by their clients and/or firm, the trader may attempt to flee. This is why it's called a Rio trade. The idea is that they hop on a plane to Rio to avoid scrutiny from their employers, clients, and financial regulators for their actions.
Example of a Rio Trade
Here's a hypothetical example of how a Rio trade works. Let's suppose a stock trader takes a short position on a high-flying tech stock just before the company announces quarterly earnings. The next day the company reports blow-out earnings and raises sales guidance for the remainder of the year. The stock soars in after-hours trading and the short seller faces steep losses on paper as a consequence. His Rio trade is a leveraged bet on another tech stock using options with the hope that this trade will bail him out. If not, he will be sharing his sorrows with Barry Manilow at the Copa Copacabana, the hottest spot north of Havana.