Investing in the stock market is a great way to make money, especially when you invest for the long term. However, there are certain risks that can be well outlined for you to understand the stock market better. These types of risks are as follows:

Types of Risks Associated With Stock Market:

Volatility:

Volatility refers to the fluctuations in the price of a stock or security over the course of a year. Not only stocks themselves, but also the market can be affected by widespread volatility. Volatility can generally occur for the following reasons:

Geopolitical Events:

In a connected world where all economies and politics are interconnected, an event that occurs in one economy can have an impact on another. For example, a recession or economic downturn in the US can have an adverse impact on economies around the world. Similarly, a military threat posed by one country to another can have an adverse impact on the economies of both countries and countries in the region.

Economic Events:

Any significant change in monetary policy, tax regulations, GDP growth, exports and imports etc. or even the weather can have an impact on a country’s economy. This in turn causes volatility in local markets.

Inflation:

Rising costs of goods and services or deliberate government measures to that effect can affect the future value of assets such that income may be reduced due to lower purchasing power. Inflation can cause volatility in markets.

The above three factors can affect the volatility of stocks or securities and cause the market to go up or down in accordance with the development of events or the rise and fall of inflation. There are several ways to manage or deal with volatility. These include buying stocks with consistently growing dividends, adding bonds to your portfolio (since bonds are generally stable fixed-income instruments), or reducing your exposure to stocks or securities that are highly volatile.

Timing:

Trying to predict how the market will develop in the future and investing in the market accordingly is called timing. It is logical to think that one should buy when the market is at a low and sell when the market is at a high. That seems like sound advice. While it is easy to think like this, it is not easy to implement the same. There is no way to tell if the market has reached its lowest or highest point. Everything is relative. when you think market is low and invest in. It may actually turn out to be a market high when the market takes another decline from your entry point.

In order to manage this time risk, which is called rupee cost averaging can be used. This means investing a constant amount of rupees when the share price falls, resulting in more shares bought. Similarly investing the same amount when the share price rises, resulting in fewer shares of the same company being bought. The result is a larger number of shares of the company at averaged costs. This can help you as an investor against market fluctuations and downside risk.

 

Overconfidence:

Overconfidence can lead to errors in judgment, resulting in incorrect investment decisions. Failure can be recognize against certain stocks, too much concentration in one stock or industry, very high leverage, and being on the sidelines of the stock market for too long are some of the effects of overconfidence.

To overcome the impact of overconfidence, one must stay grounded and use strategies to reduce the effect of overconfidence. These strategies include:

Diversification:

Risk can be spread by  buying different stocks of different industries. Buying five or ten different stocks in different industries is a good idea. To diversify portfolio you can invest in EFTs, or mutual funds.

Long-term investments:

Holding your stocks for the long term is a good idea to overcome the effect of overconfidence. Especially if you invest in good companies for a long term, say 10 years or more, you need to get good returns from such investments.

Don’t use leverage:

Try not to buy shares with borrowed money. Because you can protect yourself from market and stock market downturns or any crisis in the economy or the stock market.

So the three main types of risk associated with investing in the stock market are volatility, timing and overconfidence. Ways to manage and mitigate these risks have also been briefly outlined so that you have a smooth and productive investment experience. So go ahead, take the plunge and invest in the stock market keeping these risks and mitigating factors in mind to get good returns on your investments.