Risk in the stock market
The Stock Market is Not Risk Free!
While most people would acknowledge the financial markets are risky, it's the risks we aren't aware of that messes up portfolios. It pays to stay alert and use the science generated from markets action to minimize trouble. One more thing, stock market trouble does more than impact a portfolio. It can steer us to make decisions, forever, that are counterproductive.
Related: Mindset.
Types of Risk
Random price action. Price movement in the stock market is determined by the relative balance between buyers and sellers. There can be a well established trend but a sudden price swing may occur simply from buying, or selling, that shifts the price dramatically. It may only be for a moment, but in real time, it can provoke an emotional response and/or a decision to take action.
It explains why the stock market seems irrational at times.
Lower priced stocks in smaller companies tend to have a lower daily trading volume on average. Penny stocks are prone to wild price swings simply because the market is illiquid meaning a transaction at any given time doesn't have an equal offset.
Larger companies tend to be heavy institutionally traded stocks with a massive amount of money changing hands on a daily basis. These stocks tend to have tighter intraday ranges and a more orderly smoother pattern from one session to the next.
Each stock has its own character depending on the investors who transact in it. Amazon AMZN, for example, tends to be much more erratic than other equivalent size companies. It's not about Amazon, it's about who is trading in the stock.
The behaviour of a stock should be a significant factor in the screening process for choosing what may be held in a portfolio. If the stock is erratic or wild, how do you make an informed decision?
Earnings reports: The release of earnings to the public as required under securities laws is actually a significant risk and it's not just to disappointments. It works both ways.
The market isn't always open. A significant back log in orders can spark a large price swing at the open of the session (9:30 eastern). Material news such as earnings is reported when the stock market is closed, or the stock is halted. It is common place for U.S. stocks in particular to have price changes that are well above average on earnings.
Bias. We all have it and choosing to operate on it will impact portfolio decisions. You could be an expert in analysis, technically, but something can steer portfolio decisions in a different direction from say an emotional reaction.
Bias takes many forms. It pays to be aware of how it is making an impact in portfolio management.
Eventually the portfolio outcome will take precedence over any factor that contributed to why a stock was bought and held.
Related: See what you can do about bias and emotional driven decisions in the Mindset study.
Fixed strategy. Most retail investors think they are supposed to operate with a certain strategy. It might seem like a good idea but it is another form of bias. The stock market does not have to accommodate any bias and when it does, it is a random event. Eventually it will fail as the reality of the market's trend and dynamics are different.
Related: See the Strategy Study.
Flawed system: this isn't about the market, but rather the connection of the market to portfolio decisions. Many investors are speculative or biased, use inaccurate information or systems and don't have a system for dealing with their weakness(es). Plenty could be added to this.
Sudden events: The stock market will react to sudden real world events. It happens and you can't see it coming. Nobody can realistically.
Reality: Sometimes things happen!
Small company stocks and penny stocks
Other risks
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Your trading platform makes a mistake.
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The stock exchange makes a mistake with an order.
Stock strategy: It pays to know what works.
Terms and definitions: You'll get more using this along with standard investment terms knowledge.