By Simon Bond

The main role of a good stockbroker in this day and age, in my view, can be summed up quite simply. When people ask us what we do and what the job entails my response is as follows: “essentially we try to save people from themselves”. That response is usually met with a blank stare.

Well, over 80% of our time is spent talking people out of doing something where they don’t understand the risk, or risks. Everyone gets a tip, or a whisper at some point in time, and this is usually the best time to let the feeling pass. 

Let me explain.

Someone comes to see us with a view to investing in shares. One of the first questions I ask after they have told us what a great idea they have is this: What do you understand to be the meaning of the word risk? Many people, in fact well over 50%, will just sit and stare at you while they try to think of a response, not a clever response, just a response to the question.

My next question is this: Do you understand that an investment in shares means you may lose some, or all, of your money? Again, this question is met with incredulity as they ask: What do you mean I may lose some or all of my money?

The Oxford English Dictionary cites the earliest use of the word in English (in the spelling of risque from its from French original, 'risque' as of 1621, and the spelling as risk from 1655. It defines risk as: Exposure to the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility.

Wikipedia notes market risk as; the risk of losses in positions arising from movements in market prices. There is no unique classification as each classification may refer to different aspects of market risk.

Nevertheless, the most commonly used types of market risk are:

  • Equity risk - the risk that a stock or stock index (e.g. The Dow Jones Index or The ASX 200 or All Ordinaries Index) or individual stock prices or their implied volatility will change.
  • Interest rate risk - the risk that interest rates (e.g. 10-year or 30-year Government Bonds) or their implied volatility will change.
  • Currency risk - the risk that foreign exchange rates (e.g. EUR/USD, USD/AUD, etc.) or their implied volatility will change.
  • Commodity risk - the risk that commodity prices (e.g. corn, crude oil, copper, gold) or their implied volatility will change.
  • Margining risk -results from uncertain future cash outflows due to margin calls covering adverse value changes of a given position.

By way of illustration.

1. Securities trading risk: The probability of a loss or drop in value.

Trading risk is divided into two general categories:

(1). Systematic risk: This affects all securities in the same class and is linked to the overall capital-market system and therefore cannot be eliminated by diversification. Also called market risk.

(2). Non-systematic risk: Any risk that isn't market-related. Also called non-market risk, extra-market risk or diversifiable risk.

It’s all a lot to take in and as they say “free advice is worth what you pay for it”.