The stock market is volatile which means that the market can move rapidly and unpredictably. One day your stocks may be worth only half of the price at which you bought them or another day the value has already doubled.
Because of the market’s volatility, many people are afraid to invest in the stock market. This may be true, but it’s more important to be aware of the risks that come with it.
The best way to go about this is to educate yourself. Don’t rush into opening an account with your chosen online broker without doing your research first about the stock market. Learn as much as you can before you risk your hard-earned money in the stock market.
This article does not intend to scare you, but to warn you of what will possibly happen if you don’t study the stock market before you invest in it and why you should continue to learn even when you’re already investing.
What are the Risks Involved in Investing in the Stock Market?
There are different types of risks that every stock investor will face and below are just some of them…
1. Commodity Price Risk
This happens when a sudden change in the price of products affects the business behind the stock you own. For example, you own a stock for a fast-food chain that primarily offers fried chicken on its menu. Due to an event, the price of chicken soars high. This can affect the fast food because it will now have to pay more for its chicken. This can shake up the company a little, and cause a reduction in the price of the stock.
If you bought a stock for a poultry farm, however, and the price of chicken goes up, then the poultry farm will benefit and your stock may see an increase in price.
Even companies that are not directly related to the commodity whose price is increasing can be affected. This is especially true if it is the price of primary goods (rice, etc.) that increase. When this happens, people usually try to buy less to avoid expenses. This affects other companies since their customers generally buy less. This leads to less profits and a decrease in stock price.
2. Headline Risk
When we hear the news that a certain food product is bad for the health, we will generally try to avoid that food. This is an example of headline risk. The news may lead people to act differently and may cause their buying patterns to change.
In the more complicated levels, news about a bad economy and lots of crimes can affect the stock market because the foreigners that fund local businesses are no longer confident to invest their money here. When any of these two examples happen, stock prices may drop for a specific group of companies.
3. Obsolescence Risk
Back in the early days of the cellphone, Nokia was the top player and the biggest company. However, the company failed to adapt properly to the changing times, and eventually their phones became obsolete or no longer used. If an investor bought Nokia stocks at the start of their company, they would have enjoyed huge profits at the height of the business.
However, if they held on to those stocks until today, then they would have had a great loss. This is an example of obsolescence risk — when the businesses become obsolete and fail to adapt to the changing consumer market. Nowadays this risk is even more common since anyone can make cheaper or better versions of a product, therefore capturing the customers of a different company.
4. Detection Risk
This is also an issue that Filipino stock market investors can encounter, especially when dealing with new start-up companies.
In the business sector, there are lots of security “features” in place to make sure that the businesses are being conducted properly. There are, however, some instances when people in the businesses do illegal things such as stealing money from the business and generally mismanaging things.
There are authorities in charge of making sure this does not happen, however, they are not always quick to catch the bad guys. When this happens, the problems are only exposed when the company has been damaged. Once detected, the issue will cause the company stocks to go down significantly.
5. Legislative Risk
This is another uncontrollable issue that investors will face. There are times when the government will create new laws that are not always good for certain businesses.
For example, the government may ban mining operations from one area. They may also increase the taxes on some items that we import from other countries. This can cause problems to companies related to the materials covered by the new laws. When the change will cause a decrease in the profits of the company, this will also cause their stocks to go down.
These are just some of the risks involved in investing in the stock market. People who invest in stocks need to be aware of these risks. They should watch out for them so that they can make the appropriate moves when necessary.
Read the Stock Market Series:
- Stock Market for Beginners: What it is and How it works
- How to Choose a Stock Market Broker in the Philippines
- How much should you invest in the Stock Market?
- Stock Market Strategies: How to Analyze and Value Stocks
- Stock Market Strategies: How to Maximize your Profits and Minimize your Losses
- 5 Possible Risks in Investing in the Stock Market
- What you need to know about the Philippine Stock Exchange