Henry995_ Hill

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What is tail risk in trading and how do professionals manage it?

Tail risk refers to rare but extreme market events—such as flash crashes, black swans, or sudden geopolitical shocks—that cause outsized losses beyond normal expectations. For example, the Swiss National Bank’s removal of the EUR/CHF peg in 2015 created catastrophic moves that bankrupted many traders. Professionals manage tail risk with protective measures like options hedging, stop-losses, and capital diversification. Stress testing and scenario modeling also prepare portfolios for extreme events. While tail risks are rare, their impact can be devastating. Retail traders often ignore them, focusing only on average volatility. However, ignoring tail risk creates vulnerability to sudden wipeouts. Prudent traders always allocate part of their capital to defensive strategies, accepting reduced returns in exchange for survival during crises.