Risk is an unavoidable element in any investment, but the magnitude of the risk, whether large or small, depends on the type of product.
Investing in stocks entails a certain level of risk, which can be linked to the prevailing economic conditions, a company’s performance and stability, or market price factors.
By having a better understanding of the nature of the market, investors can mitigate risks if investments are done prudently.
The performance and financial health of companies can be interrupted by economic downturns – whether the 2007-9 global financial crisis, the 2009-19 Greek debt debacle or the current Covid-induced economic woes.
Companies could suffer financial hiccups, suffer losses or face temporary closure, or even bankruptcy in some cases.
During such periods, stock prices can plummet as investors fearing the company may collapse attempt to dispose of their shares to avoid further financial losses. New investments could also be temporarily suspended as savings may be diverted into reserved capital to meet daily needs.
Instability in company operations
A company’s performance is not always stable – it can be strong, weak or merely idle depending on the economic climate, its internal business operations and other external positive or negative factors that could have a direct impact on its business.
A fall in a company’s share price or its bankruptcy would see investors worse off. If bankruptcy is declared, common stock shareholders will be the last to receive their assets. In some cases, they may not receive anything at all if the company has large debts.
Growth in interest rates
The burden of heavy debt resulting from rising interest rates could hamper some companies’ profitability, thus impacting dividend distribution to shareholders, and this could eventually impact the value of a company’s share price on the stock market.
Illiquidity of stocks
Liquidity refers to the ease in selling, buying and converting stocks into cash. The liquidity of a stock is important as it gives investors the flexibility to avoid risks. For example, if investors wish to exit the market due to falling stocks or urgently need money for personal use, they can sell their holding stocks.
Conversely, the illiquidity of stocks means they may find it hard to sell their shares quickly at an attractive price.
Fluctuations in stock price
A sudden fluctuation in stock price can put investors in a precarious position. Such movement occurs due to supply and demand for a particular stock on the market or as a result of market manipulation.
The share price of a particular stock will jump if demand rises; conversely, it will drop if supply is higher than demand. In such an event, if investors fail to grasp the market trend, they are likely to suffer losses if they sell their stocks at a price lower than the market price.
Unscrupulous investors or traders can manipulate the market by driving up, suppressing or maintaining the price of a particular stock for their own financial gain, which could cause losses to other investors if they are not careful.
What should investors do to reduce these risks?
The popular investment mantra “don’t put all your eggs in one basket” clearly tells investors to diversify their portfolios or investments by investing in stocks from different sectors to avert colossal losses should the country of your investments face an unexpected economic crisis.
In case investments are severely affected if a country falls into crisis, investors can rely on shares invested in other sectors that remain unaffected to earn profits.
In addition to investing in companies from different sectors, investors may also consider investing in different types of companies with different market capitalisation because larger and smaller companies have different levels of risk and return.
Since business operations vary from one company to another, certain crises can affect some companies while leaving others are completely insulated. A good example is the flourishing e-commerce sector during the Covid-19 pandemic compared to many other sectors that are facing difficulties.
Choosing the right stocks
Investors should critically analyse the following factors before making an investment decision – a company’s growth potential, cash flow, revenue and earnings, its long-term strategies, business quality, share price history and stock liquidity. These factors can help investors determine the sustainability of a company’s operations and profits.
Investors should also consider companies that are committed to distributing dividends regularly so investors can earn regular income from dividends even should share prices fall during bad times.
Investors should also consult with their brokers to acquire sufficient knowledge about a particular stock before investing.
Types of investors and liquidity of stocks
While there are advantages in the liquidity of stocks, investors should also understand what type of investor they are – whether they are long or short term investors, or novice or professional investors.
As long as a company is growing, liquidity isn’t the main focus for long term investors. However, it is for short term investors because their profits mostly depend on capital gains derived from day trading.
Unlike those with experience in investing who can benefit from high liquidity stocks, the new investor with limited knowledge should buy stocks with a medium level of liquidity – stocks that need some time to get executed, as opposed to high liquidity ones that can be executed immediately.
A novice investor is then better able to learn about market movements and to avoid the strong price fluctuations that could see them worse off.
Think before investing
A fluctuation in stock price is largely influenced by supply and demand, but investors should also carefully observe as to whether it is being caused by investor sentiment or the company’s fundamentals, such as its cash flow, liabilities and growth prospects.
A change in price can also be caused by market manipulation, whereby unscrupulous investors attempt to deceive by falsifying information to mislead the price of shares to generate profit for themselves.
Investors should examine carefully what triggered a change in price before making the decision to buy or sell.
For example, if a company’s share price suddenly spikes sharply without any positive news related to the firm then investors should show caution.
Investors are recommended to follow the latest financial news – related to the economy, company operations and market movement – from trustworthy media channels to ensure investments are based on solid facts.
Moreover, to promote transparent and fair trading, the stock market, as well as securities regulators, can launch appropriate strategies so investors can invest safely in the market.
Contributed by: The Cambodia Securities Exchange,
Market Operations Department
Email: [email protected]
Tel: 023 95 88 88 / 023 95 88 85
Disclaimer: This article has been compiled solely for informative and educational purposes. It is not intended to offer any recommendations or act as investment advice. The Cambodia Securities Exchange is not liable for any losses or damages caused by using it in such a way.