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7 Types of Risk Involved in Stocks that You Should Know

7 Types of Risk Involved in Stocks that You Should Know.

7 Types of Risk Involved in Stocks that You Should Know:

“Successful Investing is about managing risk, not avoiding it.”
-Benjamin Graham, Father of Value Investing

Let me be very honest with you. Investing in the stock market is risky. If you think that investing in stocks is as safe as cash or bank deposit, then you are completely wrong.

Although historically speaking, stock market investment has given the best returns compared to gold, bond, funds or other options. However, the return from the market is not guaranteed and you may even lose your entire money in stocks.

Now, I’m not trying to scare you. But I’m just highlighting the fact. Over 90% population lose money in the stock market.

Why? Because they do not understand the different types of risk involved in the stocks.

A beginner who starts swimming know that it’s dangerous if he goes in the deep water before proper training. He knows that he might even get drawn in the water. However, when it comes to stock market, people just ignore the different types of risks involved in stocks and are ready to dive in immediately.

Nevertheless, if you know the risk, the chances are that you can mitigate it or at least can have a back plan.

That’s why, in this post, I’m going to explain the 7 types of risk involved in the stocks that you should know. Further, please read the article till the end as there is a bonus in the last section.

7 Common Types of  Risk Involved in Stocks:

Here are 7 common types of risk involved in stocks that every stock investor should know:

1. Market risk

This is also called as systematic risk and is based on the day-to-day price fluctuation in the market.

The market index Sensex and Nifty goes up and down throughout the day. And many a time, it may affect the returns from a stock. For example, if the market is going down at a time, then it might pull down the prices of even some good stocks.

Moreover, in the short term, the market risks are higher compared to the long term.

Also read: How Much Can a Share Price Rise or Fall in a Day?

2. Business Risk

The second type of stock risk comes from the business. This risk can be escalated if the business is not doing well. Reasons like the failure of management, poor quarter-by-quarter results, or your misjudgment in picking a company come under business risk.

However, you can mitigate this risk by diversification. The chance of one business not performing well is ‘high’ compared to 5 such companies. Hence, if you are keeping 5 stocks in your portfolio, instead of one, you can reduce the business risk.

Also read: Investment vs Speculation: What you need to know?

3. Liquidity Risk

Before investing in a stock, you should definitely check how solvent the company is? Companies with high debts may find it hard to pay their bills. Many times, they might even cut the dividends or in the worst case, may go bankrupt. Liquidity risks are involved in all businesses.

4. Taxability Risk

The government changes taxes all the time and hence taxes may increase or decrease in the particular industry where you invested. The change in taxation can affect the stock price.

Further, there are few industries which are taxed comparatively higher to other and hence, their net profit after tax may be less. Further, as taxation is controlled by the government, there is not much that the management or the investors can do.

For example, I’m holding the stock of ITC. During July of last year (2017), the stock price of the company fell over 15% in a day due to a news of an increase in taxation after GST in the cigarettes. A big chunk of my profit was gone that day and I couldn’t do much about it. I didn’t sell ITC because I bought it at an even cheaper price and am still bullish on this stock for long-run.

DISCLAIMER: THIS IS NOT A STOCK RECOMMENDATION, JUST MY PERSONAL OPINION.

However, before investing in this cigarette-giant company, I always knew this might happen and was willing to take the risk. Further, as a back plan, I had diversified my portfolio, which means that although ITC was down, however, other stocks in my portfolio were doing great. Therefore, the overall impact on my portfolio due to the poor performance of just one stock was quite small.

Also read: Long-Term Capital Gain Tax- Simplified [Budget 2018-19]

5. Interest Rate Risk: 

The open market or global market interest rates changes time to time. And this can positively or adversely affect the stocks depending on the direction in which the interest rate is moving. For example, when the interest rates are high, a company might find it difficult to borrow money (at high rates). Further, the bond market declines as the interest rate increases, which may also affect the corporate bonds.

6. Regulatory Risks:

There are a number of regulations imposed in the different industry which must also be termed as the risk involved in stocks. For example, Cigarettes, telecommunication, beverages, pharmaceutical and few other industries are highly regulated.

If a pharmaceutical company loses any of its drug manufacturing right/permission because of a regulatory effect, then it will definitely affect the company’s profit and hence, the stock price.

7. Inflationary Risk:

With an increase in inflation, the price of raw material will increase, which can affect the production cost. Many companies involved in commodities like oil, soya bean etc are affected a lot by inflationary risk.

Further, for few industries, the inflation rate is too high. For example, education and healthcare.

The tuition fee for schools and colleges are increasing at a very fast rate. Although, it might sound good in the short term as these industries will make money from the inflated price. However, for the long run, it might have an adverse effect on retention of the customers.

profit loss risk

Also read: Fundamental vs Technical Analysis of Stocks

Bonus: Few other risks

Beside the above mentioned 7 risk involved in stocks, here are few other risks that are worth mentioning.

  • Social and political risk: Many companies face problem due to social and political risks. For example, Tata Motors shifted its Tata-Nano plant from West-Bengal to Sanand- Gujarat because of political reason, which cost a lot of money to Tata.
  • Credit Risk: The risk that the company who issued the bond won’t be able to pay the interest or repay the principal at maturity and may find it hard to buy/sell goods.
  • FII/DII investments: The investment by big players can also be counted as the risk involved in stocks. If the foreign direct investment/ domestic investment decreases in a company, and they start selling their stocks, then it might adversely affect the share price of that company.
  • Currency and exchange rate risk: Many companies who deals across nations or the companies involved in import/export may face a problem with increased dollar price. Therefore, the currency and exchange rate fluctuations might increase risk in these companies.

Bottom line:

There are a number of risks involved in stocks. Nevertheless, if you understand the basic concept behind the risk involved in stocks, you can control the amount of risk you want to take.

Moreover, the risk is reduced over the long-term. A short-term fluctuation won’t hurt your portfolio in the long run. Further, most of the short-term market fluctuations, political, or social risks will be nullified while investing for a duration of 10-15 years.

Overall, yes!! There are a number of risks involved in the stock market. Nevertheless, risk takers are awarded in the stock market if you take ‘smart’ calculated risk.

That’s all. I hope this post is useful to you.

Please comment below which risk involved in stocks can hurt your portfolio the most.

If you are new to stocks and want to learn how to invest in Indian stock market from scratch, then here is an amazing online course: INVESTING IN STOCKS- THE COMPLETE COURSE FOR BEGINNERS. Enroll now and start your share market journey today.

Hi, I am Kritesh, an NSE Certified Equity Fundamental Analyst. I’m 23-year old and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting

Is Indian stock market risky to invest

Is Indian stock market Risky to Invest?

Is Indian stock market risky to invest? Stock market is one of the best place to make money form your investments. There are number of examples of people with average job who ended up being millionaires by investing in stocks.

For example, if you had bought 100 stocks of Bajaj Finserv in Nov 2008 at a price of Rs 100, you initial investment of Rs 10,000 would have turned out to be over 5.4 lakhs in just 9 years. In addition, dividends would also have been credited to your account every year.

Bajaj finserv share price

But this would only had happened if you had hold the stock for a period of 9 years (not selling in between just to book profits).

You can make great fortunes form the market if you have three basic qualities- Discipline, patience and persistence.

Why people think stock market is Risky?

Every investment has some risk involved in it. Depending on the type of risk taken by the investor, the reward is achieved. There is a famous proverb prevailing since a long time in the investment world- ‘NO RISK, NO REWARD’.

Those who are able to get high rewards from the market are the ones who have adopted balanced approach to minimise risk and maximise the reward.

However, there are a number of people who do not invest in stocks just because they think that the Indian stock market is too risky. 

Also read: 7 Most Common Stock Investing Myths

Is Indian stock market Risky to Invest?

The legendary Investor Warren Buffett has said a famous quote about risks- ‘RISK COMES FROM NOT KNOWING WHAT YOU ARE DOING’.

People think stock market is risky because most of them do not understand the movements in the market. The day to day fluctuations in the market makes them uncomfortable.

Many people cannot relate the upward or downward movements of the share price with the company’s performance. Hence, they think it as an another form of gambling, where no one can surely predict the future outcomes, but just speculate the market.

Moreover, due to the couple of past market crashes in the Indian stock market, most Indians are afraid that the stock market is too risky to invest. They do not want to see their investment falling to grounds.

Nevertheless, stock market as a whole has historically been the best investment for long term.

If you need to make money in next two years, invest in something less volatile. But if you want to make fortune in 20 years, invest in stock market.

Although, I agree that there are few risks involved in the market, but these are the risks that are worth taking.

There is a famous movie dialogue from the film ‘ROCKET SINGH- THE SALESMAN OF THE YEAR’ which I would like to quote here:

‘Risk to Spiderman ko bhi lena padta hai’. / Even Spiderman has to take risks. /

Risk vs. Reward

There is always a risk involved in stock market if you invest in stocks with indiscipline and without doing proper research. However, the risks involved in the market can be minimised (if not totally diminished) by following proper discipline and principles while investing.

Further, if you are happy with a 4% simple interest retun on your savings, then you should not invest in the market. Your money is a lot safer in your savings account. It won’t go anywhere and there is no chance to lose that money from savings, unlike stock market . It will idly sit in your bank account and will give you linear returns.

However, if you are not happy with the 4% interest and think that this return will not help you to fight inflation (5-6% per year), then you have to invest your money. Although, there are risks involved, but it’s better to increase your wealth by investing than to degrade its face value by inflation.

Certainly, there are risks involved in stock market investment, but a 15% compounded annual return can help you a lot in fighting inflation than a linear return of 4% on savings.

Also read: How Much Return Can You Expect From Stock Market?

Lessons from the Past:

Whenever people talk about the risks in the market, the famous example they give is the 2008 market crash.

It was the time of economic recession in India. Market fell over 60% from January 2008 to March 2009.

In short, if you had invested Rs 1 lakh at the top of the market (before crisis) and then you had taken out your investment at the end of the crisis, then the net worth left with you would have been equal to Rs 40,000 only. Your invested amount would have diminished by 60%.

Here is a graph of Sensex.

From the past data of over 45 years, 2008 stock market crash was the worst. Please notice the sharp fall in the graph in year 2008-09. This was one of the biggest market crash in Indian stock market history.

Sensex Chart- Is Indian stock market risky to invest

Source: https://tradingeconomics.com/india/stock-market

In addition, here is the records of Sensex from year 2008 to present year-2017. Please note the Opening,  High, Low and closing points of Sensex at different months.

Sensex Records from 2002 to 2017

Source: Historical Indices- BSE (http://www.bseindia.com/indices/IndexArchiveData.aspx)

Now, let us discuss the Sensex points at different time during (and after) the 2008-09 market crash.

Sensex in Jan’08 = 21,206 (HIGH)

Sensex in Mar’09 = 8047 (LOW)

During this period of 14 month, Sensex fell over 13,000 (-60%) points.

However, if you had just remained invested for 2 and half years from the crash date, you would have recovered completely from the losses.

Sensex in Nov’10 = 21,108 (HIGH)

Sensex 2008-09 Crash

Further, if you had remained invest for 6 more years since the crash of 2008-09, you would have made good profits from the market despite the big crisis period of over 14 months.

Sensex in Jan’15 = 29,844 (HIGH)

Overall, from the historical data, we can say that even the worst market crisis in Indian stock market could have been recovered if you had stayed invested for long term. 

No single market, bull or bear, can last forever. Bear market will always be followed by bull market and vice versa.

The worst thing an investor do in such situations is to panic and leave the market; booking heavy losses. 

If you had left the market during the 2008-09 market crash by panic, then you would had to book a loss of 60% on your investment. This could have destroyed your net worth.

However, if you just had patience and had hold the stocks for long term, you could have made wonders.

If you want to learn stocks from scratch, I will personally recommend you to read this book: ONE UP ON THE WALL STREET by Peter Lynch- best selling book for stock market beginners.

Risks Analysis:

It’s true that many of the small caps companies were forced to shut down during the crash due of bankruptcy. However, all the fundamentally strong companies remained intact and recovered quickly after the crash.

There are hundreds of examples of the stocks whose price fell heavily during the stock market crash. However, 9 years later, their price is sky rocketing today compared to the stock price at that time.

Here are the stock prices of 4 common Indian companies that everyone might be aware of.

Had you invested in these companies, you would have created huge wealth. Inspite of the big market crash of 2008-09, its effect are not visible on the stock prices of these companies.

  • Tata Consulting Service

TCS Share price

  • Eicher Motors

Eicher motors share price

  • MRF

mrf share price

  • Hindustan Uniliver

HUL share price

Image Sources: Google

The list of such out-performing common stocks goes on and on. The long term investors have always created wealth for the market, despite the market crashes and corrections.

Also read: How To Invest Rs 10,000 In India for High Returns?

Sensex yearly records from 2000 to 2017.

Sensex Records from 2000 to 2017

Source: Historical Indices- BSE (http://www.bseindia.com/indices/IndexArchiveData.aspx)

From the above table, you can notice that for the long term investors, the rewards have always been greater than the risks.

Sensex has given a return of over 9 times (closing of 3,972 in 2000 to 31,892 in 2017) in a period of 17 years, which time period includes one of the biggest market crash in Indian history.

Moreover, this is the return form just the index of the market, which covers the average of the market.

If you had invested in few good companies from a pile of over 6,000 companies listed in the Indian stock exchanges, you could have easily beat the market.

Your returns would have been much better than the 9 times return of the index in the period of 17 years.

Overall, stock market is risky for the impatient investors. However for the long term investors, stock market has never been risky.

Stock market has always rewarded the long term investors.

What are the real risks involved in the market?

Although stock market is safe for a long term investor, however there are few risks involved in the market. Here are the real risks that every investors should be aware of. These are those risks that turns out to be a wealth destroyer for most of the investors:

1. Speculating the market:

Stock market becomes risky when people starts to speculate. Many a time, people buy stocks just because they get intuitions that the price of that stock is going to rise. Buying stocks on speculations is always a wealth destroyer.

2. Trading in Futures and Options:

Although many people had earned a lot of money by trading in Futures and option. However, the number of people losing money in F&O is relatively high. Never enter futures and options trading without proper knowledge.

3. Entering with no Proper Strategy:

Stock market becomes risky when you do not have any proper strategy while entering the market. A good strategy covers the time to entry, time to exit, total investment amount, portfolio allocation etc.

4. Following Recommendations:

Buying stocks on ‘TIPS’ or recommendations always invites risks for the investor in the market. Moreover, following your broker or friend’s recommendation blindly has always led the investors to regret in future.

5. Not following risk management systems:

A little risk is always involved in stock market. However, by following few risk management systems, you can minimise the risks and maximise the rewards. For example, using ‘STOP-LOSS’ while trading is a good risk management strategy.

6. Trading with emotions:

Trading with emotions is always risky in stock market. Never attach emotions in the market. Do not get dishearten or proud if your stocks are doing bad or amazing in the market. Trade with discipline, patience and persistence.

7. Lack of Patience:

If you do not have patience in the market, you cannot create wealth. Warren Buffett used to say that – ‘Stock market is a place to transfer money from impatient to patient people’. Stock market is risky for impatient people. Most of the time, its the impatient people who turn out to be the losing one, transferring their wealth to the patient people in the market.

8. Non-diversified portfolio:

If you have invested all your wealth in a single stock, then there is a big risk involved in your investment. Market works on emotions. Sometimes, even the best company can become the victim of unfavourable conditions like new government norms, irregular losses/damages etc. Like the old ones used to say- ‘Never put all your eggs in one basket’. Non diversification is risky in stock market.

9. No proper understandings:

If you are investing in a company that you do not understand, you are taking one of the biggest risk in the stock market. How can you decide weather the company is doing good or bad; Weather you should hold or sell the stock; if you do not understand the company? No proper understandings of the company can freeze your decisions and will lead your investments to a big danger.

why most People lose money in stock market

That’s all. I hope this post- ‘Is Indian stock market risky to invest?’ is useful to the readers. Moreover, I hope that it can inspire the people to start investing in the market by managing the risks and focusing on the rewards.

Please comment below what do you think about this topic. Is Indian stock market risky to invest?

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Hi, I am Kritesh, an NSE Certified Equity Fundamental Analyst. I’m 23-year old and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting