We Need To Discuss The R-Word

Think Stock market and the first thing that comes to your mind is - the Stock market is risky. Without brushing the "risk-factor" aside let's take it head on. Let's instead of making loose assumptions, try to understand the types of risks and the methods to either neutralise or minimise it. Stock investment is indeed risky, but over the years several potent methods have been devised which have helped investors to safeguard their interest at the same time secure handsome returns.

Risk management is a critical aspect of stock analysis and good stock advisory firms spend a lot of time on assessing stocks on the risk they pose. So let's explore the types of risks retail investors face in stock market.

Company Specific Risk

Company specific risk is only limited to the company which might be in question. As you must be aware that a stock's performance is heavily relied on how the company performs. For example, Tata Motors is trading at 500. The market sentiment is good and there is an increased demand for heavy goods carriers. These circumstances, in every likelihood, will make the stock price surge upward. Now just change the scenario; if there is a strike in the company, and it gets prolonged and there is no production in the company, then stocks drop. No one sees it coming, but it happens and affects the stock, that's company specific risk.

Retail investors shouldn't get discouraged by such hiccups, as in the life-cycle of every company, such issues occur. Efficient management resolves such issues in no time. A smart investor will look at this as a window of opportunity; as the stock is available at discount. Investors with long-term investment perspective needn't worry about these glitches as no sooner the issues are resolved the company starts its upward trend.

Sector Specific Risk

Sector-specific risk affects only the sector which, due to some event, gets adversely affected. Sometimes it also has a cascading effect on the related sectors e.g. if real estate gets hit due to some government policy change, so along with real estate related sector like cement will also get affected. In the recent past, due to demonetisation, real estate and infrastructure sectors were heavily affected. In the period of 2 months, most of the top real estate and infra stocks were dropping day after day. But they recovered as soon as cash flow in the market normalised.

For example, when Reserve Bank cuts the repo rate banks stocks rally as the policy change directly boost the banking business. Similarly, if the government imposes some addition tax on banking transactions it might disturb the market sentiment and the banks' stocks may suffer. However, just like company specific risk, no one can predict this and long-term investors are immune to its adverse effects.

Market Risk

Market risk is not limited to any company and its performance, it affects the stocks of all companies across the sectors. Market risk is a global phenomenon. Major global, political events i.e. Brexit, results of the U.S elections or Fed rate hike have the potential to affect markets across the globe. In the same line, inefficient government, delay in bringing in promised reforms pose a risk to the market. It has a blanket effect on the whole economy and on all the companies. Same for a natural calamity, as it immediately upsets the market sentiment.

Things To Remember

In the cycle of the economy, phases like prosperity, slow-down and recovery keep recurring. As a consequence, stock market too keeps swinging either way. The best remedy to survive market risk is to go long. Yes, companies, sectors and even market keeps falling and raising, but long-term investors can easily sail through the bumps of the market as good stocks over a long period of time always make up for the lost time and delivery good results.