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Market Risk and Other Types of Risks: What to Consider When Managing Your Own Investments

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Market Risk and Other Types of Risks: What to Consider When Managing Your Own Investments

Experience is one way to figure out how to handle various risks on your own. But we recommend you a less stressful alternative: read this article. The more you know about these risks the easier it is to avoid or handle them.

Market risk
What is Market Risk

market risk explained

Market risk, in a nuthsell means the risk that arises from the possible negative movements of your positions in your portfolio. In other words there is always a risk that whatever you purchase will loose some or all of its value over time.

Market risk
Risk of choosing a bad broker

After deciding to invest on your own for sure, you are going to need a brokerage company where you can open an investment account.

What should you consider here?

While it's somewhat easier to avoid than market risk, the biggest risk is that your broker is a scam and steals your money. “How to earn 1000 EUR a day with 1 hour of work?” or “With this new investment scheme you can buy a yacht in 3 months?” - Do you recognize these aggressive marketing banners? If something sounds too good to be true, then it is not true. This applies for the brokers as well. Please avoid these scams.

Investor protection is crucial as well. The protection depends on the country where the broker is registered. As you can probably imagine, you do not get the same protection in Cyprus as in the UK.

And last but not least, it is important to find a good broker suitable for your investment needs and experience level. Let’s assume that you are a fresh driver and you need a car for cruising in the city. You do not know what type of car you really need and you drive out from the dealer with a Hummer. No doubt, you can drive it in the city, but it will consume like hell and you may have some problems with the parking as well. Not an ideal decision.

This is the same with the brokers. You have to balance between

  • the trading platform,
  • the research quality,
  • the trading cost
  • and the product/market spectrum.

When you are a rookie the usability of the trading platform and the research quality is the most important. After gaining some routine the trading cost and the product/market spectrum are getting higher in the priority list.

How to handle these risks?

It is very simple, use Brokerchooser. We pay high attention on pre-selecting the best brokers for you. Use our questionnaire to find the best broker suitable for your experience and needs.

Market risk
Taking too much risk

Before you jump into your first trade we highly recommend to think about your risk tolerance level. Why? Because we want you to have good sleep in the future as well.

What should you consider here?

Imagine Tom, who has just got a phone call from his ex-classmate, Lukas. Lukas works at a brokerage company and he is sharing with Tom the business plan of the “next Facebook”. Lukas says that after the IPO the company will double or triple its share price. Tom convinces himself that this is his big shot and he wants to jump in. He is thinking “how nice would it be to buy that weekend house I was dreaming about all the time”. But with the current amount of his savings he cannot do that even if the share price would triple. Lukas incepts the idea of taking some leverage which means Tom will risk even more than his current savings. So he ends up taking mortgage out on his flat and investing everything in the “next Facebook”.

After the IPO it turns out that the company cannot grow as fast as the management predicted and the share price halves in a few months.

How does this influence Tom’s life?

He starts to have nightmares, cancels his holiday since he has to pay back the mortgage and he gets even more far from his dream.

Tom obviously took too much risk.

Taking too much risk means that someone is losing more than he can tolerate.

The risk tolerance level varies in the case of each investor. The goal is to find yours.

Why is that important? Because without identifying your tolerance level you can risk and you can lose more money than you can handle.

How do you know that you are risking too much? Symptoms of taking too much risks are:

  • sleepless nights;
  • you feel that one of your financial goals are endangered;
  • or the worst: you do not know how to pay your bills.if your risk tolerance level is low. A stock index can lose more than 50% of its value during a crisis. Is that in accordance with your risk tolerance? Obviously NOT! In this case you would better go with a government bond portfolio and have a good sleep.

Market risk
How to handle this risk?

You have two steps to follow.

Step 1: do not invest more than your savings.

This is one of the lessons we can learn from Tom’s story. If you do not follow this rule, you can easily find yourself in tough financial situations. That can even destroy your current standard of living.

Step 2: Know your risk tolerance level

Let’s assume you invest all of your savings. Now ask yourself: how much percent of loss in a year makes you feel those symptoms from above?

If the answer is:

  • after 5%: your risk tolerance level is low;
  • after 10%: your risk tolerance level is medium;
  • after 20%: your have high risk tolerance level.

Again, why is this important? This serves your calmness. If you know how much loss you can tolerate that will help you in constructing your investment strategy.

Just to give you an example: it is not recommended to invest all of your savings in stocks if your risk tolerance level is low. A stock index can lose more than 50% of its value during a crisis. Is that in accordance with your risk tolerance? Obviously NOT! In this case you would better go with a government bond portfolio and have a good sleep.

Market risk
Risk of making mistakes

Making mistakes is inevitable when you are investing.

What should you consider here?

You have to keep in mind that making investment mistakes is absolutely normal. Even professionals do a lot. Warren Buffett, probably the most successful investor in the 20th century, made quite a few confessions about his investment mistakes in the yearly shareholder letters.

What are the most frequent mistakes?

  • Making bad investment decisions. E.g. you expect the oil price to rise, but Saud Arabia suddenly increases its output and the price eventually declines.
  • Not following your investment strategy. E.g. your investment period is 6 months but you are restructuring your portfolio after 2 months.
  • Not keeping up to date your controlling tool (e.g. excel file) for your portfolio and at the end of the year you do not know if you earned or lost money.
  • Execution mistakes: you think you have placed a stop loss order on your gold position but you have not.

How to handle these risks?

  • First of all, do not be too hard on yourself. That only makes you frustrated and you should remember: even Warren Buffett made a lot of mistakes.
  • Be diligent and patient and follow your strategy! Maneuvering out from your plan will only bring you stressful situations.
  • Practice and learning goes hand in hand here. The more you practice investing, the less mistakes you will make. But improving your knowledge is also very important. Several investments books are must reads. Investment courses and educational sites could also help.
  • And keep your eyes open: follow the market and the news and think of it as a big financial board game.

Market risk
A Quick Summary

Ask these questions about yourself and think about what it means?

  • Should I invest more than my savings?
  • What is my risk tolerance level?
  • How can I find a good broker for my needs and experience level?
  • Is it normal to making investment mistakes?
  • What are the most typical investment mistakes?
  • How can I decrease the number of mistakes I could potentially make?

Do not worry these are tough questions, and we bet your answer will change throughout time. The interesting bit is that you will need different skills for being an investor and a trader. Here are first 10 steps for both.


Market risk and beyond - continue learning

Tibor Bedő

Tibor Bedő

Co-founder, CEO

Author of this article

Tibor believes having a good stockbroker is everybody's privilege. He worked extensively in the financial industry, including at Morgan Stanley and at The Boston Consulting Group (BCG). He advised leading European banks on strategy, finance and risk management.

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