“Investments in securities markets are subject to risk”. is a disclaimer that you often come across as an investor or trader. Have you ever thought about the kind of risks prevalent in the securities market? If you are an investor who has been investing in the securities market for a while or a newbie investor willing to try your hand at investing in the securities market, it is a must for you to understand the types of risks that may affect your investment.
We are here to help you. In this article, we will introduce you to the key risks of the securities market
Key Risks in Investing in Stock Market
Systematic Risk or Market Risk: It is a risk inherent to the securities market. It is the risk faced by investments due to the overall performance of the market and the general economy. It is the risk of the fall of an entire market as opposed to an individual company.
Black Monday of 1987, the stock market crash of 28-Sep-2008, market crash of March 2020 due to the pandemic are some of the examples of systematic risk or market risk.
Systematic risk being associated with the entire market eco-system, it comes unpredictable most of the time. There are a few mechanisms like hedge portfolio, contra market return products, known co-related market products to avoid the consequences of systematic risks.
Unsystematic Risk: Contrary to systematic risk, unsystematic risk is the risk associated with the individual company or industry. It is also known as specific risk, non-systematic risk, residual risk, or diversifiable risk.
Some of the factors that may lead to unsystematic risks are:
A new competitor in the same industry
The inefficiency of the management
Flaws in the business model
Changes in the capital structure
Production of non-desirable products
Labour strikes, etc.
The unsystematic risk may be in the form of business risk that happens when the business of the company may get affected or may stop its operations due to any unfavourable operational, financial, or market conditions.
Since unsystematic risks are diversifiable, they can be minimized. If you diversify your portfolio by buying shares of different companies and also in different sectors, you can avoid the unsystematic risk to an extent.
Inflation Risk: Also known as Purchasing Power Risk, it is the risk of chance that the cash flow from an investment would lose its value in the future because of a decline in its purchasing power due to inflation. The inflation risk is common in all types of investments.
The inflation risk is time-bound. Portfolio adjustments and planning such investments that offer a better inflation-adjusted rate of return are some of the ways to elude inflation risk.
Liquidity Risk: Liquidity risk arises when you can’t buy or sell your investment quickly enough. For example, if you have securities of a small-cap company and want to sell the same to divert the funds towards a different asset class. But if you don’t find any buyers to sell those securities, then you are facing liquidity risk.
To avoid liquidity risk, look into the volumes traded before buying any asset class. Click here to learn more about liquidity risk.
Volatility Risk: Volatility risk arises when the company’s price fluctuates over a period of time. You need to look into the price stability, volumes traded, price fluctuations in the recent past, and other measures to avoid volatility risk.
Currency Risk: It is the potential risk of loss that may arise due to fluctuating foreign rates. This is the risk you may face when you have invested in foreign currency or foreign currency-traded instruments.
Above are the potential risks you may face with your investments. Though you cannot evade these risks when you are investing, you can mitigate these risks by various measures and products. Click here to learn more about risk and its management strategies that are in practice.
In this article, we have only introduced you to the risks in the securities markets at large. You need to weigh the risks and returns associated with each investment before putting your money into it. Note that analysing risks and returns should be an important factor in your investment decision because there is no risk-free return.