The definition of risk is “being exposed to certain danger”. In the financial markets, it may be defined as “the possibility or likelihood of loss”.
So in investing, what are the different types of risk?
1. Market Risk. Stocks will tend to move in the direction of the overall market. So if the market goes up, your stocks are likely to follow – as is the case when the market goes down.
If we are in a bear market, in which there are more sellers than buyers, the stocks you own will follow. They may have rock solid businesses, and make a ton of cash. However…no stock is immune to market risk.
2. Stock risk. This, in my opinion, is more dangerous than market risk. It’s the risk of losing money because there is something fundamentally wrong with the company.
For example, Bed Bath & Beyond (NASDAQ: BBBY) has been a poor investment for the last five years. Here are the reasons why:
1. Amazon has significantly disrupted their business, and they haven’t been able to fend them off like Best Buy (NYSE: BBY) has successfully done.
2. They have been forced to close non-performing stores, and they’re getting squeezed because they have to continuously lower their prices. Lower prices mean lower profits.
3. Poor management. Bed Bath and Beyond’s management has purchased billions of dollars worth of stock at significantly higher prices. Their capital allocation has been abysmal.
As an individual investor, these are the risks you face: market risk and stock risk. At some point, you will experience both, and it doesn’t mean that the stock should be sold. Evaluate the situation. Determine whether it’s a market issue, or company-specific. Even if it is company related, that doesn’t mean it can be fixed.
Just know what your risks are.
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