Facing Risks in the Stock Market

Risk in the stock market is one of the most misunderstood investment concepts because it comes in various forms including market risk, opportunity risk, and inflation risk. Market risk can be defined as the inherent risk associated with market forces. When you are faced with an economic sacrifice resulting from having to forgo the benefits of alternate investments, then that is opportunity risk. For example, if you have $10, 000 tied up in one investment, that money can’t be used elsewhere. Inflation risk affects all investments, some more than others. Inflation is generally described as economic increase in price level of goods and services. Investments need to overcome inflation risk by making a higher return that the rate of inflation. All the risks must be assessed before investing even a penny. Remember, you are ready for investment if you can afford the risk.

Your Personal Financial Mentor notes that an investor should assess the likely risk since it is his/her worst enemy. It puts the investor in stress and stress produces incomplete knowledge access. This reason sums up why trading coupled with stress can lead to loss of capital. It definitely seems ironic that people who take up trading from their day jobs in order to reduce the stress of not making enough money from it end up creating more stress. Trading in the stock market can be an extremely stressful endeavor. You should really know what you are doing otherwise stress will be pervasive and you may ultimately end up not enjoying what you are doing. Avoid improper decisions as they can ultimately lead to rapid losses and running down of your hard earned cash.  This can lead to a higher level of stress than you ever experienced.

Today’s markets are highly unpredictable. Employ a low stress trading approach that matches your risk tolerance for you be successful in your investment endeavor. The right step to beginning with is to assesss the risks involved and determine how much risk you can handle. Asses the risks that your investment may face as this will help you avoid the associated stress thus help you to invest wisely. About two billion shares trade hands in the three major U.S. exchanges every day. It is a fascinating process, considering each trade reflects the expectations of two particular investors i.e. buyer and seller.

Investment setting

One interesting thing about the stock market is its ability to digest information. The stock price of a company may go up or unfavorable go down depending on how information concerning the company is disseminated. For example news that INTC has developed a new and faster computer chip will make the stock rise, while news that Microsoft is being investigated by the U.S. Department of Justice will sent the stock price of MSFT down. Many investors in such scenarios sit on the sideline until the uncertainty ends.  The stock market works that way. Unfavorable news concerning a company leads to a drop in the stock price. If you purchase shares in a particular company today and tomorrow there is bad news about that company, the value of stock holdings of the company will fall upon the news. This is the risk of owning stocks; they can periodically decline in value.

When a stock decline in value, an investor hopes it will recover, but sometimes it doesn’t, and it does, it may take an incredible amount of time to do so. An investor trading in the stock market faces the risk of stock price falling instead of rising.

What is stock?

Stock signify an ownership in a corporation. Thus, you become a partial owner in a corporation when you purchase stock. The percentage of stock you own depends on the number of shares purchased and the size of the company. Take the case of Intel, which has a total number of 3, 349, 000, 000 shares.  If you purchase 100 shares of Intel, you become a fractional owner of the company. Your ownership becomes 1/33, 490, 000. You still have rights as a shareholder no matter how small and insignificant the shares you own. The rights is a shareholder include:

  • Right to profits
  • Right to vote
  • Right to information

We see that the most important right shareholders have is the right to share in the company’s net profits. The value of a company is direct function of the profits that it is able to generate. For example, someone offers to sell you a corner grocery store in your neighbored.  After going through the books, you figure out the store didn’t make any money in the last 10 years. If you buy the store anyway, either you are going to suffer financial losses or you must turn the business around so that it makes money and you can get paid.

The same is applicable to stock ownership. A profitable company has earnings which are either reinvested back into the company or distributed to stockholders. When a company distributes a portion of its earnings, the payment is referred to as dividend. If none of the earnings are being passed on to stakeholders as dividends, then they are most likely being reinvested to fuel the company’s future success and profitability.

A shareholder has the right to information.  Annual and quarterly reports are provided to all shareholders and are available to the financial public at large. There reports contain information including business developments, updated financials, and assessment of the business outlook for the coming quarter and year. Stakeholder have the right to vote on major issues facing the company such as selection of accountants, whether to accept takeover offers from other companies, or authorizing the distribution of additional shares. Well, in such a circumstance, the votes of individual investors are relatively insignificant. Stocks are trades on organized exchanges throughout the world, or on a computerized system. These exchanges set rules and procedures that foster a safe and fair method of determining the prices as well as provide an environment for trading of stocks.

Categories: Stock Market

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July 13, 2013 Facing Risks in the Stock Market