Market risk is a risk of losses an investor may experience due to the movements in market prices. This is also referred to as “systematic risk “or non-diversifiable risk because it relates to factors, such as recession, that impact the entire market.
Classifications of Market Risks
There is no unique classification as each classification may refer to different aspects of market risk. However, the most commonly used types of market risks are:
- Interest Rate Risk – The risk that interest rates or their certain volatility will change.
- Currency Risk – The risk that involves the change of the implied volatility of foreign exchange rates will change.
- Commodity Risk – The risk of the change in the volatility of commodity prices.
- Margining Risk – results from uncertain future cash outflows due to margin calls covering adverse value changes of a given position.
- Equity Risk – the risk involving the change in implied volatility of stocks or stock indices.
- Liquidity Risk – a risk that involves the availability of time given to a certain asset to be traded.
Why is it Important to Know the Risks?
Every Investor faces a market risk as a securities market follows economic indicators, recessions and normal business cycle. Most investors know that investing involves risks as well as rewards and that, generally speaking, the higher the risk, the greater the reward. It is also important to know the risk so that an investor would be able to counter them, or at least deal with them strategically.
The most basic strategy for minimizing market risk is diversification. A well-diversified portfolio consists of securities from various industries, asset classes and countries with varying degree of risk. The specific risks will offset each other but some market risk will always remain.
Learning about the forces that could impact your investment will also work. If you are considering to invest in a particular sector, read and study about its industry. If you are thinking about investing in foreign securities, learn as much as you can about the market history and volatility, socio-political stability, trading practices, market and regulatory structure, arbitration and mediation forums, restrictions on international investing and repatriation of investment.