Understanding Market Risk

Market risks have little to do with a company’s overall strength, and more to do with the affect the world’s economy can have on the market.

The stock market is always volatile. There are risks involved in investing your money in a company’s stock. Savvy investors take the time to research the company thoroughly before investing in its stock. But one risk investors often overlook is market risk, or the volatility of one market and how it might affect another. This was seen in February 2007, in a dramatic turn when the Chinese stock market dropped a whopping 9% in a single day, causing a tidal wave effect throughout the world. The United States Dow Jones Industrial Average fell by 4.3% in the Chinese aftermath, its worst decline since the terrorist attacks of 2001.

The International Organization of Securities Commissions urges investors to take the time to learn what market risks are and how they may affect investments worldwide.

Market risks have little to do with a company’s overall strength, and more to do with the affect the world’s economy can have on the market.

Interest Rate Risks

Changes in interest rates directly affect the value of bonds. As interest rates rise, the price of previously purchased bonds falls; while dropping interest rates will increase the bond’s value.

Inflation Risks

Inflation reduces a consumer’s purchasing power, which also reduces the value of investments.

Currency Risks

When purchasing stocks or bonds issued by companies outside of the United States,any fluctuation in currency exchange rates can directly affect how much a stock or bond really costs, and how much you’ll make when selling it.

Liquidity Risks

The ability to sell off your investments at the moment you choose can greatly affect your profit margins. Being unable to make trades due to foreign regulations, not being able to find a buyer, selling at a discount, among other reasons may cost you valuable assets.

Sociopolitical Risks

Worldwide events such as a terrorist attack, war, and even an election can all affect investor attitude toward the market and cause serious up or downturns. Worse yet, some catastrophic events can lead to wide-spread disruptions in financial markets all over the world, which can be risky for individual investors.

ICountry Risks

Country risks are similar to sociopolitical risks, with one important exception: they are tied to a specific country and the economic and political climate within it.

Legal Remedies Risk

When dabbling in the oversees market, keep in mind that problems which may arise with your investment must be handled by that governments market overseers, which may work very differently than those your used to in the United States. This in itself can be very risky for foreign investors.

While no one can completely avoid all market risks - that’s what makes the financial market so profitable - there are a few things every investor can do to minimize the risk.

Do Your Homework

Take the time to research all of the things that can affect your oversees investments. Stay tuned to global economic trends and changes, and be certain that you completely understand all of the trading practices, regulatory practices and restrictions in investing internationally.

Diversify

Vary your holdings by region, country, length of holdings (long term vs. short term), product, and sector.

Investing is always risky. But don’t let that scare you. Oversees markets can be very profitable, as long as the investor understands the ever-changing market risks associated with specific investments and takes the necessary precautions.