Types of Risk

by Manshu on September 23, 2006

in Articles

Risk is a very important factor to be taken into consideration when deciding to invest in the stock market. Any investor thinks that big profits are a good thing and risk is a bad thing. The thing is that usually risk and profits go hand in hand, they are even some times directly proportional (the bigger the risk, the bigger the winning possibility).It’s known that investments on the stock market are risky investments, but building up an equilibrated portfolio can limit the risk. Its important to understand what you are dealing with and risk can be broadly categorised as follows:

Company RISK

Every company has its own risk that varies, of course, from organization to organization. So, we can find companies with low risks which usually are big stable companies, with shares worth a lot, and companies with a big risk factor or companies that never paid their dividends, that belong to an unstable economic area and their shares are worth less. To decrease the risk, even when the only intention is to speculate a little, it is recommended to invest part of the capital in low risk companies and the other part in high risk ones.
Studies conducted over the America market show that having a portfolio of at least 10-20 different types of stocks can almost eliminate the company risk.

Sector RISK

Diversifying your portfolio doesn’t only mean to own stocks from different companies, but also to own stocks from different economic sectors. The sector or industry risk threatens companies that produce similar or interdependent products, so that the investors in a certain sector have to be aware of the high risk factor. So, investing in independent sectors can be a method to diminuate the sector risk, with the possibility of conserving the initial value of the portfolio.

Market RISK

The market risk is also called the un-diversifying risk, because this risk can not be avoided no matter how many different stocks might be present in the portfolio.

In any country there are political and economical issues that can make the prices of stocks to be badly predicted and so the market risk increases. This is the only actual risk. All others can be avoided easily: lose a little with one company, but win a lot with all the others.

The market risk is to be anticipated sometimes if analyzing the situation of the country and economy itself. First determine expected political or economical changes. Then try to guess other unexpected measures that might occur. And only after that you will have to ask yourself in what way your companies will be influenced, witch sectors will grow and which fall.

{ 2 comments… read them below or add one }

Mayank Gupta September 28, 2012 at 9:32 pm

The biggest indirect risk of investing in stock markets esp. in direct stocks is risk of ignornance
1. Ignorance on how to diversify a portfolio across sectors
2. How to read a company, stock, company balance sheet
3. How stock market sentiments define stock price etc

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Manshu September 29, 2012 at 5:11 am

That’s an interesting thought, I’ve never looked at ignorance as a risk factor.

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