Types of Stock Risk
Do any apply to your shares?

Stock risk varies in terms of the extent to which it affects the whole stock market or particular stocks.

Systematic risk or market risk is the risk inherent in the whole market or market sector.

Sources of systematic risk include interest rates, recession and wars because they affect the entire market and cannot be avoided through diversification.

Systematic risk or market risk can be mitigated only by being hedged. Even a portfolio of well-diversified assets cannot escape this risk.

Unsystematic risk is stock risk that affects a very small number of assets or one stock. It is sometimes referred to as specific risk.

News that is specific to a small number of stocks, such as a sudden strike by the employees of a company you have shares in, is considered to be an unsystematic risk.

Financial risk is the risk that a company will not have adequate cash flow to meet financial obligations.

It is the additional stock risk a shareholder bears when a company uses debt in addition to equity financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly or entirely by equity.

Sovereign risk is the risk that a country will not be able to honor its financial commitments. When a country defaults it can harm the performance of all other financial instruments in that country, as well as other countries.

Legislative risk or regulatory risk is the risk that legislation by the government could significantly alter the business prospects of one or more companies, adversely affecting an investment holding in that company.

This may occur as a direct result of government action or by altering the demand patterns of the company's customers,

An example of an industry with high legislative risk is healthcare. Drug manufacturers and healthcare providers both must contend with many ongoing legislative issues related to government subsidies, insurance coverage and other customer payment issues.

Liquidity risk is the risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. This is usually reflected in a wide bid-ask spread or large price movements.

Smaller companies shares tend to have lower liquidity as fewer investors are interested in buying them.

Political risk is the financial risk that the government of a country will suddenly change its policies. This is a major reason that third world countries lack foreign investment.

Price risk is The risk that the value of a stock or portfolio of stocks will decline in the future. It's the risk that you will lose money due to a fall in the market price of a stock that you own.

Currency risk or exchange-rate risk is the risk that changes in currency rates may impact on the earnings of companies that generate overseas income.

This might be mitigated by undertaking currency hedging which is a form of insurance against unfavorable changes in currency rates. But this is an additional cost to the company.

Of course, changes in currency rates may also have a positive impact on foreign income if the change occurs in the right direction.

If for example Australian exporters are selling their products and receiving U.S. dollars and the AUS dollar appreciates in relation to the U.S. dollar, they will receive more A$s when the funds are returned to Australia.

Australian importers of U.S. goods, on the other hand, will have to hand over more AUS dollars to buy goods in U.S. dollars.

Transformation strategy risks or investment risks arise when a company embarks on a new venture which is designed to have a major bearing on the future direction of the company. Significant capital or other investment expenditures may be involved with uncertain outcomes.

Besides the risks mentioned above that relate to companies, investors create their own risks.

Day trading risks are incurred on a regular basis by day traders, CFD traders and other high risk investing types who speculate on the daily ups and downs of the stock market.

Investors who dabble in penny stock investing and hedge fund investing expose themselves to a range of risks, some of which are mentioned above.

Given the range of risks investors and companies face over time, it is not hard to imagine that there is no such thing as risk free profit, whether for the individual or the company.

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