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What is Price Risk?
A price risk is the risk that an investor will invest in an equity that will eventually be worth less than what they paid for it. There are ways to manage price risk, but as long as there is some investment going on in unsecured products, there is no way to totally eliminate it. Therefore, the question is often how to mitigate market price risk and what to do when it starts to become a severe problem.
The goal of any investment is to make money. However, the risk associated with the practice of investing is real and will mean there will always be some losers. The ultimate question is to determine how much price risk is worth the potential rewards. This may be a little different for each investor and can even be different for the same investor, depending on what their goals are with an investment project.
Price risk management is meant to help lessen any potential impacts of devaluation. This may be done with a standing order to a stock broker, for example. In this case, an investor may have a broker sell a stock once its value drops to a certain level. Often, this order is given well in advance of a price drop. This helps prevent any further losses, but will not recoup any loss of value up to that point. If the value of the stock starts to increase, there may be a standing order that dictates when to repurchase that stock.
Another strategy of price risk management is to diversify a portfolio. Diversification will often involve the purchase of stock from two industries that are somewhat opposed to each other in their function. For example, if an airline stock is doing badly, perhaps a stock dealing in some other sort of mass transit area, such as bus travel, may be doing better. Therefore, finding a good balance could help reduce some of the price risks.
The question of how much price risk one is willing to put up with may be a function of where they are in their investing lives. Those that are using investments as a way to collect money for retirement and are first starting out will likely be more inclined to put up with a greater risk. However, those who are closer to retirement will not be willing to put up with the same amount of risk simply because there is less time to recover it.
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![One strategy of price risk management is to diversify a portfolio.]()
By: diego cervoOne strategy of price risk management is to diversify a portfolio.
Discussion Comments
One strategy I have used for risk management in buying and selling stocks is to first do my homework - that means research stocks I'm interested in, and study their performance over time.
Then when the stock market goes down, or some part of it, I would watch for a strong company whose price has gone down, then I would buy when the price is quite low. The price risk is good that it won't go down too much farther and then will come up. This doesn't always work, though. The stock market is hard to predict.
One's age or rather how close one is to retirement makes a big difference in the amount of price risk that you want to take. If you are just starting out, your price risk can be much higher.
You have many years to ride the ups and downs of the market. And if you diversify your choice of stocks or mutual funds, and if you buy stable stocks that pay dividends, your price risk can be high.
On the other hand, the closer you are to retirement, your price risk should be lower. You need to be conservative so you don't risk losing money and not having time to recoup your loses. You need all the money you can get for retirement.
@Azuza - I've been looking into doing some kind of automatically monthly investing. I think it sounds like a really good idea.
I know investing always has some kind of element of risk, but it can pay off big time. Probably because it is so risky! But for less daring types of people such as myself, risk management is essential. I'm not willing to risk totally losing all the money I've invested.
@oasis11 - I've also found mutual funds to be a good way to minimize my risk when investing. I used to put a certain amount of money in a mutual fund every month, and over the course of about two years I made a lot more money than if I had just put it in the bank.
Unfortunately, I had an emergency and I had to take the money out. I was planning for it to be a more long term investing strategy, but circumstances got in the way. If I'm ever in a position to resume investing, I think I will go with a mutual fund again.
@subway11 - I do the same thing, investing a certain amount every month. Apparently, it's called dollar cost averaging. I mostly invest in index mutual funds, so over time they will generally go back up.
The nice thing about dollar cost averaging is that it manages your purchases. When stocks are expensive, you don't buy as many (because your monthly amount won't buy as many shares). That also reduces your price risk, because you're not buying as much when they're high.
Then when the market is down, another way to think of it is that stocks are "on sale," so you buy extra shares!
@Oasis11 - I know what you mean, but I like investing in dividend earning stocks. I usually invest in blue chip stocks that offer a healthy dividend yield this way if the stock price does go down; at least I have earnings from my dividend payments.
I also like to invest the same amount on a monthly basis which allows me to take advantage of the market and get more shares when the market is down. I try to stay with companies and industries that I am comfortable with because if not, I won’t know when to pull out.
I always stay on top of the business news surrounding the companies that I invest in and I think that it is important to do that in order to proactively manage risk. I do have a rule which states that if the stock price dips 15%, I generally look to sell my shares. I think that a drop that significant usually means something unless the entire market was like that.
What I try to do is invest in mutual funds instead of single stocks because with mutual funds you really are investing in an entire sector rather than investing in a single company. I really like investing in index funds that encompass the entire US stock market and well as mutual funds that focus on foreign investments.
I realize that it isn’t easy to deal with the inherent risk of investing in securities but historically, investments in mutual funds and stocks have outperformed most other investments over time. I don’t worry about the fluctuations in the market because I am a long term investor with a long time horizon.
I think that the only time I would consider selling my shares is if there is a change in the mutual fund management. I try to invest in stable funds that have had the same management for years. This is how I try to manage my risk.
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