A Short Lesson on Stock Market Risk

Just because I buy a stock does not mean that, I have taken risk.

Example:

I buy 5 stocks.

All with the same position size.

I make 10% each on 2 of those stocks.

I lose 3% each on the remaining 3.

How much do I make ?

20% on winners.

9% on losers.

Net net, I gain 11%.

If I buy the 6th stock, with a 5% stop loss, does it mean I have taken risk ?

Technically, no.

I am just risking a portion of my gain.

I am not risking my capital.

They say, "The stock market is risky."

My question to them is:

How risky ?

Risk is a very subjective topic.

Risk can come from:

- Current portfolio situation

- Current personal situation

- Chart

- Fundamentals

If there is a medical emergency in your family, will you take huge risk in the market ?

If you are in a bad mood, will you take huge risk in the market ?

The correct statement is not "The stock market is risky."

The correct statement is: "The behaviour of the stock market trader could be risky."

You might say, "What about gap down risk?"

Yes, that is a real risk that exists in any stock.

There is also overnight risk.

The point is: these risks can be managed.

There are 3 ways of manage risk:

- Position sizing

- Stop loss placement

- Both of the above

A professional trader could end up taking a 50% position size in a stock and still end up with almost zero or negligible risk in the portfolio.

Regards,

Rohit Musale, CFA

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