Investors first measure the risk of individual common stocks followed by making the decision whether the investment will be beneficial or not. Various methods are available for measuring the same, such as Standard deviation, Sharpe ratio, beta, value at risk, r squared and conditional value at risk.Every method mentioned has different basic of functioning but the end result of all of them is very similar and reveals the level of risk involved in an individual stock (Gärtner, 2017).
Standard deviation is the basic method of measuring risk of individual common stocks which are used by most of the investors. It measures the dispersion of the information and data from its value that is expected by the global market. It is very effective in making decision related to investment wherein the level of historical volatility is linked with the investment and the relative rate of return derived from the investment annually. The result reveals the deviation of the current return rate from the historical returns expected value. For instance, the individual common stocks that shoes high standard deviation value shoes that it is prone to high volatility and thus involves higher risk of the stock and thus the investor can decide that the particular investment will not be beneficial so doesn’t make the investment. Contrary to it, low standard deviation shows lower volatility indicative of lower risk and thus will be ideal choice for the investor (Pederzoli, 2017).
Those investors who wish to understand the potential losses and ignore the related potential gains can also opt for semi deviation method of measuring risk of the individual stock. Semi deviation method takes into consideration standard deviation of the downside thus lets the investor decide either is favor or against of making an investment based on the level of risk involved in the individual common stock (Entrop, 2016).
Investment risk is the notion that an investment will not perform as expected. Normally, stocks are subjected to two major types of risks; market and nonmarket risks (Rudy & Johnson, 2016). Market risks are the risks associated with a specific stock’s price, which affects the overall stock market investments. In contrast nonmarket risks are the risks that a specific company will highly impact the price of the stock. The nonmarket risks are minimized by diversifying. This can be achieved by purchasing various different stocks in multiple companies whose prices of stock show minimal correlation to one another. Market risks, on the other hand, cannot be completely eradicated. However, one can measure a stock’s previous historical records in the market and select the favorable ones.
There are various methods that investors can use when measuring investment risks to determine whether an investment’s potential benefits are worth risking your portfolio. One of the methods that can be used to measure investment risks is the standard deviation (Charles, Darné, & Pop, 2015). It is the measure of an investment’s actual returns from the average total returns in a specified period. If the standard deviation is bigger, it shows that there are larger differences between actual total returns and the average total returns. This makes the risk higher. In contrast, if the returns have a small standard deviation, they have low volatility making the risk to be low. Standard deviation can be applied when measuring the volatility of any investments. Therefore, standard deviation is an important tool when measuring the risks of different types of investment before an investor can invest their portfolio.
Risks remain a challenging topic that is hard to quantify and define. As a result, most investors have different definitions of risks as they try to redefine risk in terms that make sense for their portfolio. However, understanding risks is a necessity for all investors.