Risk refers to the possibility of an event which one dose not except to happen and therefore that event cannot be determined. Risk is present in everything; however stock markets are by nature very risky due to presence of so many factors. Let’s look at different types of risks which are associated with investing in the stock markets –
1. Market risk – It refers to the risks which arises due to variety of factors which are beyond the control of anybody such as war, politics, natural disaster etc. Though all asset classes are exposed to market risk like this, but stock markets by their nature are most affected by this kind of risk.
2. Interest rate risk – It is the variability in a security’s or stocks return due to changes in the level of interest rates. Other things being equal stock prices moves inversely to interest rates, so if interest rates rise stock prices will fall and vice versa. Closely associated with interest rate risk is the inflation risk, because as inflation rises government resorts to tight monetary policy that is increasing interest rates.
3. Financial risk – It refers to risk when a company takes too much debt, due to which the company has to pay too much interest to its creditors. During high interest rates environment it will result in company paying more interest, which in turn will result in lower profits and eventually lower return for the shareholders of the company.
4. Liquidity risk – Another risk which is associated with stock market is the liquidity risk that is failure to take money from stock market when it is needed by the investor. When markets are falling liquidity risk is more evident because in some stocks there are no buyers of the stock, which forces the investor to sell the stock at throwaway prices resulting in loss to an investor.