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You can reap serious rewards from investing in the stock market, but there is a certain level of risk involved, too.
But the potential for losing money with some of your investment choices shouldn’t be a reason to stop you from getting involved in the stock market if you’re interested.
Rather than playing it ultra-safe and never buying or selling stocks, a better strategy is to learn about stock market risks and educate yourself on ways to mitigate those risks.
In this course, we cover the most common risks in the stock market and show you how to minimize your level of risk when investing.
The Truth About Stocks
The most important thing to remember during your investing journey is this: Returns are not guaranteed, and investors may lose money when buying and selling stocks. The basic nature of the stock market fluctuates, and without those changes in the market, there would be no significant profits either.
One simply cannot exist without the other, and your best course of action is to balance investing goals and risks along the way. But stock market risks are no reason to forgo investing entirely – there will always be some level of risk involved in the stock market; you just need to understand the risks you’re dealing with.
Types of Stock Market Risks
While it’s impossible to predict the changes or risks in the stock market with 100% accuracy, it’s important to familiarize yourself with the different types of risks and how they may affect your investments.
Many risks are out of your control because of economic reasons, company performance, and a host of other factors. With these types of risks, there are limited actions you have for recourse.
There are other risks you have some control over and there are steps you can take to mitigate risks; we’ll cover those strategies further on in this lesson. First, let’s start with the most common market risks.
Volatility of the Stock Market
There are lots of unpredictable factors that may influence the up and down nature of the stock market.
The volatility of the stock market is crucial to understanding the overall concept of risk. A stock that’s considered volatile is riskier than those that are not. The following are all elements that can contribute to stock market volatility:
- Commodity Price Fluctuations: Whether a company sells commodities or not, price fluctuations of commodities can affect the overall health of the stock market. Commodities like oil, coal, and natural gas are building blocks for a significant number of companies. When the price of commodities swings significantly in either direction, investors can expect to see some effect on the stock market.
- Bad Press: The media also plays a large role in the stock market. If a company receives significantly bad press, often their stocks will drop as a result. Bad press can also affect entire industries depending on the topic.
- Geopolitical Instability: Major geopolitical events such as recessions can have a significant impact on the stock market since companies often have global connections that affect their performance anywhere.
- Credit Ratings: All companies are assigned a credit rating. Investors can use this credit rating to help inform their trading decisions and predict whether a company will be beneficial to become a shareholder or not.
- Regulatory Compliance and Legislative Concerns: Every company is subject to some level of regulatory compliance and legislative concerns. This could include new taxes, more stringent regulations, or changes in industry standards. The level of concern and regulation varies by industry, but how much a company is impacted can have significant repercussions on investment opportunities.
- Rate of Inflation: Depending on how the value of goods and services rises or drops in the future, the investments you make now may or may not be as profitable down the road. Your investments now are subject to general inflation.
Although not always the case, economic events or crises can have a negative impact on the stock market. And when some sort of economic downturn happens, the stock market can drop dramatically, as we saw in the 2008 financial crisis.
In 2008, when the stock market plummeted, banks scrambled to recover from the growing amount of defaulted housing loans. The companies who worked with those banks took a hit, too. As a result of those companies’ struggles, their stocks fell significantly.
More recently, COVID-19 has impacted the stock market. As the virus began to spread, businesses across the world were forced to halt operations. And with businesses shuttering their doors, foreign markets began to fall – all impacting the U.S. stock market.
Timing the Market
It may seem like a simple solution: buy when the prices are low and sell when they’re high. But the market changes rapidly and it’s nearly impossible to predict its timing.
Attempting to time the market is one of the most common stock market risks because it seems simple enough on the surface. But it can result in wasted time and money that you could have otherwise spent making less risky investment decisions.
Just as the prices of stock can rapidly climb, they can come crashing down just as quickly. There’s a level of risk that’s involved with being too aggressive or too conservative.
3 Strategies to Mitigate Risks of the Stock Market
We’ve covered common risks you’ll want to stay aware of, but how can you manage your risk level?
Again, there’s no way to completely omit stock market risks, but there are strategies to help you make wise investment decisions.
Consider the following tips and continue to do your research to ensure you make the best possible trades.
1. Invest for the Long-Term
The stock market can crash unpredictably, but historically, it’s performed considerably well. Aim to make investments with the long-term in mind rather than the short-term.
To help mitigate your risk of losing big, only invest with money you’ll be okay going without for at least a few years. Otherwise, if you move too much of your funds into the stock market and find you need them sooner rather than later, you could be forced to sell too early and lose on your investment.
2. Learn from Trusted Sources
You can certainly make all of your investment decisions on your own, but it’s never a bad idea to consult a professional broker or another trusted source.
Not only is understanding the stock market hard work but keeping up with the market’s ebbs and flows is a full-time job in itself.
If you’re unsure of your level of knowledge surrounding the stock market, don’t hesitate to consult with another trusted resource to learn more. After all, knowledge is one of your best defenses for lowering your risk!
3. Diversify for Stability, Growth, and Extreme Upside
Rather than putting all of your eggs into one basket, so to speak, another great way to protect against stock market risks is to diversify your investment portfolio. That way, if certain stocks perform poorly, you’ll have a better chance of coming out unscathed.
In general, you should try to diversify your investments with different companies in a variety of industries rather than only investing in one industry or company. If one goes down, you’ll still have stocks that are up.
When it comes to successfully trading in the stock market, it’s always best to err on the side of caution rather than react when the market’s moving quickly. Diversification can help mitigate some of the risks involved with an ever-evolving market.
Test Your Understanding of the Stock Market
In this module of the Money Morning Profit Academy, you learned about funding different types of investing accounts, how to open a brokerage account, and how to manage stock market risks. Test your knowledge with the short quiz on the next page.