Various Types of Risks When Trading in Stock Market
When it comes to investing in stock market people commonly ask, “what are some of the most risk free investments which guarantee good returns?” Well, there is nothing wrong in looking for safe investment opportunities but in reality there are N numbers of risks in investing. Warren Buffett said “Risk comes from not knowing what you are doing”.
So, let’s first understand various types of risks that are associated with trading in Share Market.
What is risk?
Risk can be defined as the possibility of losing some or all of the principal amount. The unsurety of the return is also risk.
What are the various types of the risks once I start trading?
- Economic Risks
One of the most common risks of investing is that the economy can go bad. After the market bust in 2000 and the terrorists’ attacks in 2001, the economy went into a deep recession. A number of factors saw the market indexes lose significant percentages. After many years market came back to pre – 9/11 marks, but again in 2008-09, the economy collapsed.
Inflation destroys value and creates recessions. Even though, we generally feel that inflation is under our control, the solution of higher interest rates may at some time be as bad the problem. With the enormous government borrowing to fund the stimulus packages, it is just a matter of time before inflation hits back. Investors during such times, move back to hard assets like real estate and valuable metals especially gold.
- Volatility risk
Volatility is the magnitude or the range the stock is moving in. For example, bigger companies that are prices at $200-$600 per share might move up or down $6-$9 in a day. It creates buzz. For stocks that are just $10 per share, it may only move up or down $1 in a day’s time as a maximum. This doesn’t scare people and they feel safe. It is less volatile. Think of volatility as the range, not the direction. It implies the magnitude of the move (up or down).
- Overnight risk
For day traders who hold a stock from the morning of the opening bell to the closing of the opening bell, there is no overnight risk. But, if you are long-term investor, holder or swing-trader- there may be overnight risk if you hold a position overnight or for many days. You have no idea what will happen overseas etc. For example, a company that sells car products may have an engine explosion in US causing the stock to crash the other day (your stock would change overnight).
- Liquidity risk
Liquidity problems generally take place when you are trading penny stocks. But, if you trade stocks that are trading heavily with very liquid companies, like Netflix, Apple etc. in the present time then you will be fine. This is the reason why big institutions avoid trading low-dollar stocks. They need liquidity- they require to get in and get out of companies really fast. If you find it hard to get out of companies quickly when required, the stock is not liquid which makes it complex. You may be forced to hold onto a position that is tanking.
- Margin risk
Margin risk takes place when borrowing money- if you are borrowing money on margin. When trading and putting on a regulation account and using available funds, that is good. But, borrowing funds from a brokerage house and not paying back the money in a particular time period leads to margin risk.
- Market risk
Market risk describes what can happen to the market. Examples include incidents or events that can affect global economy, your current country etc.
- Trade risk
A trade risk is what you are trading. For example, if you put $1000 on a trade, that is your trade risk.
- Market value risk
Marker value riskindicates towards a situation when the market turns against your investment. This occurs when the market goes off chasing the “next hot thing” and leaves many good, but uninteresting companies behind. It also takes place when the market collapses- good and bad stocks suffer as investors withdraw from the market.
- Execution risk
The time between when you see your price and when the trade actually goes to the market.
- Business risk & technology risk
A few years back typewriters and pagers were of great importance, but today they are nowhere. Same is the case with floppies and audio tapes- what would have happened to these companies.
- Government risk or political risk or regulator risk
Say you have invested in a particular sector and government comes up with an adverse policy, so what will happen in such condition. This risk can be clearly seen in oil and gas or sugar sector.
Now that you know the most popular market risks, trade accordingly. You can’t eliminate all the risks, but by being careful you can avoid some of the risks.