RISK

12 May 2016 By PDSNET

The probability that a share price will go down rather than up. All investments have an element of risk, which is always harder to quantify, mathematically, than their return, and therefore very often left to the "gut feel" of the investor. Generally, the rule is that the more risky an investment is, the higher its potential return must be in order to attract investors. To understand this, it is necessary to consider what you are actually doing when you buy a share or other investment. Essentially, you are in the business of forecasting the future. You are saying that you are buying that particular share because you believe that its price will go up. Now ask yourself, "What is the easiest price chart to predict?" - obviously, a straight line! So, to the extent that a share price chart departs from a straight line, it becomes more volatile, less predictable - and more risky. A stable share price is easy to predict - but volatility makes it possible to make higher profits by buying low and selling high. So, in the share market, volatility, predictability and risk are really all the same thing. Risk can be either "systematic" or "unsystematic". Systematic risk refers to the risk that the entire market will fall, while unsystematic risk is that risk which attaches to the share itself. Risk can also be either "technical" or "fundamental". Technical risk is the risk that the share chart shows that it is over-priced and due for a correction. Fundamental risk is the risk inherent in the company's financial statements - for example, it has very high debt levels and is over-geared.



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