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A Complete Guide to Understanding Investor Risks

stock market
20 Jun 20246 mins readBy MOFSL

Introduction

In the investment world, risks refer to the probability that actual returns on an investment will deviate from the anticipated returns. Here, decisions and timing are all that matter. If you can make the correct decision at the perfect time, you are a successful investor, and vice versa. Explicitly talking about taking risks in the market that include liquidity risk, credit risk, and others, many investors make common misjudgments regarding the extent of risks they should take in an investment.

But how does it happen? How do investors get risk wrong? 

In this article, we will understand in depth how investors get risk wrong, leading to heavy losses in the market.

Common Reasons Behind Getting Risk Wrong

Investors often think that their risk calculation is perfect; however, there are quite a few factors that they need to pay attention to for getting their risks wrong.​​​​​​​

Here are the common mistakes that investors make to get their risk wrong:

  • Not Aligning Investments with Financial Goals

Another crucial factor to ensure that your risks get right in the market is aligning your investment with your financial goals. As an investor, you must know of the investment potential and take risks in the market accordingly. 

The risk of losing money in the market minimises if your investments align with your financial goals.

  • Judging by Volatility

A major mistake most investors make in the stock market is judging a stock by its volatility. Undoubtedly, the volatility of a stock can be used to predict its sentiments and the direction it might go quickly. However, many investors often need to judge an investment more carefully and consider it much more riskier than it is. 

This is because investors judge the stock by volatility. If the stock is highly volatile, most investors might avoid putting their money into it and miss potential profit-making opportunities.

  • Depending on Past Statistics

Calculating the risk associated with a stock, depending on its past statistics, is a mistake most investors make. Although this fact cannot be denied, as an investor, one can get a lot of insights and risk assessments from past stock statistics.

However, relying solely on a stock's historical volatility should not be considered since past performances consistently predict the correct future result.

  • Misjudging the Type of Risk Involved

As investors, most people only focus on the market risk. The market risk involves losing money if a particular stock's share price goes down. However, they need to consider other risks. 

These risks include credit risk, liquidity risk, and inflation risk. Hence, the overall profit percentage is highly affected, and investors cannot make money from the market.

  • Investing in Single Sector

Investing in multiple stocks of the same sector can be a risk-taking step in the market. It is pivotal to know that you need to diversify your investment portfolio. When a particular sector in the market is performing exceptionally well, most investors (specifically beginners) seek to invest money in multiple stocks related to a specific industry only. In the bull run to make maximum profits, investors often need to remember the importance of diversifying the investment portfolio.

Misjudging risks because investing in multiple stocks within the same sector is risky. If the sector fails for any reason, your entire portfolio will suffer. Diversifying your portfolio to invest in multiple sectors can minimize such risks.

Conclusion

To conclude, being a core investor in the market, considering such common pitfalls can significantly benefit you. The above-mentioned factors are how most investors get their risks wrong in the market. 

Hence, developing a more realistic view of the risks associated with investing in the market will help you make more informed decisions as an investor. 


 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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