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Investing Risks

"What types of risks are there in investing?" an SA user asked me.

Market Risk:

Most people understand the most obvious form of risk, known as market risk, or exposure to declining prices. This is only the first of many risks every investor faces and needs to manage.

Managing risk refers to how you structure your investments to maximize profits while minimizing the chances of losses. This requires careful selection of stocks based on sensible criteria, avoiding putting too much capital into any one stock, and continually monitoring the market to spot changing trends. It also requires that when considering any one company as a possible investment, you know what trends to examine and how to determine market risk based on the indicators you pick and track.

Will the value rise or fall? Realistically, you should understand that a stock's market value may either rise or fall. As apparent as this seems, some investors assume that their entry price is the "zero" point and that prices will rise from the level as soon as a buy trade is entered. This ignores the reality that prices can also fall. So managing market risk comes down to how well you select stocks to buy. The better you are able to pick stocks appropriate for you and to determine when to buy shares, the less exposure you will have to market risk. The price changes are caused by many factors, but as a general rule, the concept of supply and demand determines the value of shares.

Market risk is the ultimate expression of supply and demand. After you purchase shares, many changes can occur. If the demand for a company's shares is quite strong, prices will continue to rise; if demand is weak, prices might fall. When the supply and demand for shares are about equal, the price tends to stay within a narrow range. This condition, known as consolidation, is best described as a time of indecision. No one can tell whether buyers or sellers are in command and, as a result, it is impossible to predict whether then next price direction will be upward or downward. Market risk is easily observed in hindsight. Everyone can see when they should have bought shares and, just as important, when they should have sold.