Understanding Unsystemic Risk

Editor's Note: You can find our complete library of free investing articles here.

Stock trading is inherently risky. Trading is a hazardous occupation and participants must risk a part of their capital if they are to receive any return on their investment. Some traders win, but some lose too. It is important that you understand the chief risks that will confront you as a trader so that you can take steps to contain them as much as possible.

Understanding key risks enables you to counteract forces that are unhelpful to the prices of your shares and minimize the impact of those forces on your investments’ profitability.

Let’s talk about one of those risks: unsystemic risk.

[VIDEO] Understanding Unsystemic Risk

Unsystemic Risk

Unsystemic risk, in contrast with the wholesale and unavoidable risks of a system, is the intrinsic hazard associated with a particular stock.

Stocks inevitably align those who invest in them with the fate of the companies to which they correspond, for better or for worse. Many factors influence company performance. Some present opportunities but others constitute risks. And, because these risks are tied to the performance of individual companies rather than all companies, they are termed unsystemic.

The following are a few unsystemic risks to consider:

– Unexpectedly low earnings
– Lawsuits
– Scandals
– Technology obsolescence
– Employee strikes

Any one of these risks could cause a company’s shares to plummet. Yet, as you must realize, the list of unsystemic risks to which an investment might be subjected is almost infinite and constantly lengthening. In the 21st century U.S, you might add, for example, the risks posed by terrorists, by Internet whispering campaigns, by bird flu, by power grid failure and so on. This susceptibility to unsystematic risks is inevitable despite many larger companies employing dedicated staff to predict and address them.

Unlike systemic risks, you can counteract unsystemic risk by diversifying your investments across a wide range of companies, sectors and markets. It is also advisable to hedge your positions and thereby protect yourself, to some extent, against cumulative loss.