WHAT IS Unlimited Risk
Unlimited risk refers to the risk of an investment that has unlimited downside potential.
BREAKING DOWN Unlimited Risk
Unlimited Risk is the opposite of limited risk. In unlimited risk there is a potential to lose more than your initial investment, which is possible in short selling or in trading futures contracts. Risk itself refers to the probability that an investment will have an actual return different from the return that the investor expected. Risk ranges from losing some of one’s investment to potentially losing the entirety of the original investment.
Risk varies from investment to investment, and one form of assessing risk can be calculated by using the standard deviation of the historical returns or average returns of a specific investment, with a higher standard deviation indicating a higher degree of risk. Though the process may be intimidating, investors make high-risk investments regularly and for various logical reasons. The main justification is that, in finance, the greater the risk to an investor the greater the potential return. The higher potential return compensates for the additional risk taken on by the investor.
Examples of Unlimited Risk Investments
The most common examples of investments with unlimited risk are short positions and futures contract trading. A futures contract is a kind of financial contract that obligates a buyer or a seller to sell an asset at a future predetermined date and time. Traders use futures to speculate on price movements of underlying assets, and most commonly appear in the commodity market.
The holder of a futures contract must fulfill the terms of his contract, but in actuality the underlying goods in futures contracts are rarely physically delivered. Investors can hedge or speculate on the underlying contracts without actually holding the contract until expiry and delivery of the goods. In order to benefit from futures, investors use the movements in the prices of the underlying assets to anticipate an increase or decrease in the price of that underlying asset in the future.
Short positions are another type of investment with unlimited risk. Essentially, a short position involves selling first and then buying later, with the expectation that the asset’s price will drop. In a successful short position, the price at which the investor sells the asset is higher than the price at which they buy the asset later. Investors commonly take short positions on the Forex market, where private banks, commercial companies, central banks, investment management firms, hedge funds, retail Forex brokers and investors can buy, sell, exchange and speculate on currencies.