Market Risk

• Perhaps the most significant risk an investor faces is overall market risk. Market risk is the risk that every stock incurs simply by being part of the broader market. You can pick a great stock, which does well for a period of time and then falls dramatically as part of an overall market crash. After the 9/11 attacks, for example, nearly all stocks suffered dramatic losses, as the Dow Jones Industrial Average (DJIA) sold off over 500 points. Other major events have been known to cause similar market crashes, and there is nothing an investor can do to avoid this kind of risk. Market risk affects the market as a whole, and cannot be diversified away.
  
  

Interest Rate Risk

• Stock prices tend to fall when interest rates rise, which makes every stock subject to a degree of interest rate risk. This effect is caused by investors shifting money out of equities and into bonds, certificates of deposit, and other fixed income investments, to take advantage of the higher interest rates. Although this risk cannot be eliminated, it can be reduced by keeping informed on Federal Reserve interest rate policies; reducing stock holdings; avoiding new stock purchases when it is likely that rates may rise; and keeping at least 25 percent of available assets in cash and short-term investments.
  
  

Liquidity Risk

• Liquidity risk is incurred particularly when investing in smaller companies and in stocks that are thinly traded. If you're looking to sell a thinly traded stock, it may be necessary to reduce your selling price dramatically, particularly if you have a large number of shares to sell, in order to find buyers for all the shares. Liquidity risk is always present but may be reduced by investing in large-cap companies and in companies that normally have a large number of shares traded, since the lower the average volume of shares traded, the higher the liquidity risk.
  
  

Competitive Risk

• All companies have competitors. A company may see its stock rise dramatically in response to the success of a hot new product, only to see it fall to its original level, or even below, should a competitor introduce a product that is preferred by the market. Since successful products always invite competition, investors should be wary of stocks whose price has risen in response to products that can be easily imitated or replicated by competitors.
  
  

Legal and Regulatory Risk

• Many stocks fall in response to legal and regulatory risks affecting the company. Product liability suits, such as those brought against drug companies, the tobacco industry, and auto and consumer product manufacturers, can have a dramatic impact on stock prices. In addition, changes in government regulations, such as those affecting the telecommunications industry, or the introduction of new regulations, can negatively impact companies' stock. Investors should therefore keep abreast of all legal and regulatory developments affecting companies in which they have invested.