I RIDE IN AT LEAST

two taxicabs every day. Each trip poses more statistical risk of injury to me than al Qaeda, lightning and a plane crash combined. Indeed, there's risk everywhere, both in our lives and in our portfolios. Is XYZ risky? Yes, but so is getting out of bed in the morning. The real issue isn't whether you should take any risk at all you should but rather deciding which risks are worth taking and how you should go about approaching them. The best investors are risk managers who know when to bet,

fold

and

double down

.

First off, accept that risk is everywhere. That's why I don't discriminate among stocks, bonds, options or anything else with a bid-ask spread. In my world, every investment is considered risky. There's even risk in sitting all in cash, most notably the risk that your purchasing power won't keep pace with inflation. The young millionaire who played it safe back in 1970 by keeping his money in the bank is a relative pauper today.

Even short term, sticking with what seems safe can be anything but. For example, crude oil and natural gas historically have been closely correlated, with a 10-year correlation of near 0.95. If natural gas rallied sharply, you could reasonably bet that crude oil was eventually going to come along for the ride. This past month or so, that "sure thing" has failed horribly. Crude has rallied while natural gas has dropped like a stone, with the spread between the two widening by over 30%.

When a Layup Hits the Rim

United States Oil (USO) vs. United States Natural Gas (UNG), 2 months

An investment's risk can't be quantified by the headlines. Most commentators would suggest that buying home builders, names like Hovnanian Enterprises, Beazer Homes, Lennar and D.R. Horton, would be risky right now. And in my opinion, they'd be correct yet not because of weakness in the housing numbers but because of weakness in the securities themselves. Home builders right now are low-probability trades, so if weak stocks are risky stocks, they're not the type of risks I'd want to take.

In reality, the fact that XYZ is considered publicly risky can be even more reason to consider buying it. As I've discussed many times over the years, the "risky" investments are often the most successful. Markets change over time, and what matters isn't how XYZ has acted over the past 40 quarters but how it's acting today. So for my money, the right risks to take are those with a risky reputation but strong price action. I know I'm on the right track when I suggest someone buy a certain security and they immediately dismiss it as "too risky."

Take gold. Back in 2001 when I was making the case for gold under $300 per ounce, most people dismissed commodities and stuck with what were considered solid names like Pfizer and General Electric. If they took positions in gold or commodities, it was likely with "play money," nothing like the significant allocations that are now commonplace in portfolios large and small. The perception has completely changed. Back then, buying gold was considered to be risky. Now most would consider it prudent diversification. Attendance in commodity-related conferences and newsletters has also boomed.

It's one of the main behavioral factors that's kept me interested in the weak dollar trade I've been talking about for the better part of two years. While Europeans have 100% of their assets in euros, most Americans would be skittish about even allotting 5% to the currency. Yet the price action has been unrelentingly positive. What scares us isn't the trade; it's the idea. Turkish lira or South Korean won "feels" risky. In actuality it's just another ticker like International Business Machines or Sirius Satellite Radio.

And with good position size, risk limits and technique, traders shouldn't run from risk but embrace it. So think about the risky-sounding markets with attractive price action. Think about the tickers that have unmistakable bids but unrecognizable symbols. Think about the trades that most people would consider off-the-wall but are working nonetheless. In the vast majority of cases, the real opportunities lay in those securities.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. He's scheduled to give the keynote address this Thursday at The Money Show San Francisco.