Risk is defined in financial terms as the chance that an investment’s expected actual gains will differ from an expected return. Risk includes the possibility of losing some or all of an original investment.

While it is true that no investment is fully free of all possible risks, certain securities have so little practical risk that they are considered risk-free or less risky.

Riskless securities often form a baseline for analyzing and measuring risk. These types of investments offer an expected rate of return with very little or no risk. Oftentimes, all types of investors will look to these securities for preserving emergency savings or for holding assets that need to be immediately accessible.

Examples of riskless investments and securities include Certificate of Deposit (CDs), government money market accounts, and United States Treasury bills. The 30-day United States Treasury bill is generally viewed as the baseline, risk-free security for financial modelling. It is backed by the full faith and credit of the United States government, and given its relatively short maturity date, has minimal interest rate exposure.

More specifically, investing in exchange markets involves risks. And the following are the risks that every stock faces

• Commodity Price Risk
• Headline Risk
• Rating Risk
• Obsolescence Risk
• Detection Risk
• Legislative Risk
• Inflationary Risk 
• Interest Rate Risk
• Model Risk

Risk Of Investing in the Exchange Market

In the capital markets, investment contain elements of risk. Investors do not know with any certainty the results that will be obtained from its investments. In these circumstances, it is said that investors face risks in its investments. Investors can only estimate the expected profit of the investment and how far the possibility that actual results will be deviated from the expected results.

We recommend that investors should be cautious in making investment decisions by understanding the information relating to the company that issued the stocks. Usually, investors need to initiate the analysis of the company, namely fundamental analysis and technical analysis. By doing technical analysis, investor uses past price change data to estimate the price of the securities in the future, whereas fundamental analysis relates to the financial performance assessment of the effectiveness and efficiency of the company to reach its goals. 

To analyze the performance of the company, investor may use financial ratios to predict stock prices in the future by estimating the value of the fundamental factors that affect stock price and applying the relationship of these factors to obtain the estimated stock price. 

Investment risk in the capital market consists of two risks, namely the systematic and the non-systematic risk. Systematic risk refers to risk of market uncertainty affecting the entire economy, which automatically affects the company. While non-systematic risk refers to the risk factors unique to each company; it only affects one company. 

When investors make decisions to buy shares hoping to earn high profits, they should be willing to bear the fact that risk is also exist. Based on that, then in investing in the stock market, investors should consider the risk factors. The risk factors of investing can be measured by beta. The higher beta stocks, the higher the systematic risk. 

Beta is a concept that measures the expected move in a stock relative to movements in the overall market. When a beta is greater than 1, it suggests that the stock is more volatile than the broader market. And a beta less than 1 indicates a stock with lower volatility.

Before investing, investor should carefully check, for instance, 5 years of historical stock price of the company. The stock price is one indicator of the successful management of the company. If the stock price of a company always increases, the investor should considers that the company succeeded in managing their business. The investor confidence is very beneficial for emitter, as more people who believe in the issuer’s willingness to invest in listed companies stronger.

The more demand for the stocks of an issuer, the more it raises the price of the stock. If the high stock price can be maintained, then the confidence of investors against listed companies are also getting higher and this can increase the value of the issuer. Conversely, if the price of the stock has decreased continuously, it means it can lower the value of the issuer in the eyes of investors or prospective investors.

Non-Systematic Risk

Non-Systematic Risk or company-specific risk is probably the most prevalent threat to investors, who purchase individual stocks. You can lose money if you own shares in a company that fails to produce revenue or profits.

Lower sell, poor marketing or poor operational performance can cause a company’s value to drop in the market. In some cases, a company can report great sales and profit figures, but its growth isn’t strong enough to meet overly optimistic investor expectations. In the most extreme circumstances, companies can completely collapse, resulting in the total loss of any capital invested.

You can reduce company risk by researching and investing in valued company. Investor must analyze quarterly earnings results, listen to management commentary on those results, and measure performance with different financial ratios. Make sure that your company or stock valuation makes sense based on its potential profits.

Company’s stock valuation is the most common way to value a stock, and it is done by computing the company’s price to earning P/E ratio. The P/E ratio equals the company’s stock price divided by its most recently reported earnings per share (EPS). A low P/E ratio, must be around 16 USD, implies that an investor buying the stock is receiving an attractive amount of value.

For instance, in the world of stocks, investors should check P/E index, a price earnings ratio based on average inflation-adjusted earnings of a company from the previous 10 years. The median P/E Ratio has historically been around or below 16, which is a good barometer of what value an investor should be targeting. Again, a P/E of 16 means that it costs an investor about 16 USD for every one USD of earnings they receive by investing in that stock. The higher the P/E ratio, the more investors are paying for each dollar of earnings. For instance, an investor should consider to invest in a company that has a lower P/E or below 16, rather than a company with a higher P/E or above 20. 

Looking back in time, we can see that there have been a few periods that the P/E Ratio for the S&P 500 has been above this level. Before the crash of 1929, prices almost doubled and investors were paying up to 30 USD for every dollar of earnings from the S&P 500. And during the dot-com boom, investors were paying even higher for companies that had zero earnings.

Although there have been massive research by investor, sometimes it’s still difficult to predict what the future holds. Therefore, diversification is the only way to effectively eliminate company-specific risk. Mutual funds and Exchange Traded Funds are also great tools for this purpose. Also, investor should strongly consider investing in other assets than the paper assets. For instance, gold and real estates. 

Systematic Risk

No matter how well an investor research and invest in the valued stock, its stock is still subject to volatility and market risk. There are element affecting stock prices more than company risk. For instance, stock prices are determined by supply and demand, like every other product. If people are pulling capital out of the stock market, then stock prices are going to fall.

For example, investors can hedge against systematic risk by preparing themselves emotionally and positioning their portfolio to avoid the biggest drops. Additionally, to prevent losses, the investor must avoid selling stocks when the market is down. Holding on through a downturn keeps you in a position to reap returns when the market returns to growth. Make sure that you have an emergency cash outside of your investment portfolio to cover unexpected expenses or opportunities.

You can also build a portfolio to limit volatility. Once again, diversifying the types of investments you own can help as well. For instance, by investing in gold, energy, or Certificate of Deposit CD. Defensive stocks and dividend payers tend to experience less volatility than growth stocks. Investors should also keep some of their assets in bonds.

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