The risk-return tradeoff links potential investment returns with the risk accepted to pursue them. Safer choices generally offer lower performance potential; aggressive choices may produce more, but can fail more severely. section 7.3.2
Use the tradeoff when choosing between active trading and long-term investing. Both require downside-risk management, but temporary declines may be tolerable for long-term investors unless the underlying product becomes obsolete. section 7.3.2
Treat these strategies as high-risk implementations:
- Leverage borrows money to invest, amplifying gains and potentially producing disastrous losses. section 7.3.2
- Short selling bets against a stock and can create theoretically unlimited losses when its price rises. section 7.3.2
- Derivatives can magnify both gains and risks. section 7.3.2
Separate risk appetite—willingness to take risk—from risk capacity—ability to withstand losses. A strategy that feels acceptable in theory may exceed the losses you can actually absorb. section 7.3.2
