Systematic vs Unsystematic Risk

Systematic risk a.k.a market risk or un-diversified risk is the uncertainty arises from market sentiment towards the financial market. One good example is the incoming interest rate hike that Fed might impose in June 2016 as well as the recession as the public perceived. As such investors and traders usually would observe that there are much volatility (stocks price fluctuation) in the market.

Some of the ways to reduce systematic risk is to do hedging. As systematic risk underlies all other investment risks, depending on situation one should adopt different strategies accordingly. For example if there is inflation, one can invest in stocks that are in the inflation-resistant economic sectors. If interest rates are going to be high, one can choose to sell utility stocks and buy into newly issued bonds as bonds and interest rates tend to be negative correlated. However, if the whole economy tends to be sluggish, the best is to buy into defensive industry stocks.

For volatility due to systematic risk, one could also make use of the volatile market to acquire more shares as per discussed in the previous session.

Un-systematic risk a.k.a specific risk or residual risk is the uncertainty that a particular industry present. One good example is strike by the employees or lawsuit against the company you invested in.

One good way to reduce un-systematic risk is to own a diversified portfolio of stocks. A good diversification of portfolio usually consists of more than 30 companies across difference industries. 

Making use of Market Volatility

Most of the traders especially the day traders or swing traders make use of the market volatility to make money from the financial market.

For example if the price of a particular stock swing from $0.90 to $1 within a time frame of few minute, few hours or few days, depending on the trade amount, one can make about $100 - $1000 if one trade size is (1,000 to 10,000) shares. By using a capital outlay of only $900 - $9000.

However trading does not come without risks. In order to mitigate the risk from using the same amount of capital, one should make use of the market volatility to its own advantage.

For example, if one already evaluate a particular company and deemed that the price is at a safety margin range to buy, one could do the followings:

Share A has an intrinsic value of $3 and because of the market volatility, it has fallen to $2.50. Imagine you only have an investment capital of $5000, you could buy 2000 shares.

When the market pushes up Share A price to say $3.20 (for example), you could sell it for $6600. As the market is in downtrend and there are volatility, one can then wait for the price to drop again. When the market has pushed down Share A price to $2.80 (which is below its intrinsic value), you can then buy 2300 shares ($6600 / $2.80 = 2357.14).

Notice that you "gain" additional 300 shares without additional funds.

You can thus repeat the cycle over and over again which could let you own more shares overtime without additional capital outlay.

Adopting this strategy thus allowing you to own more shares with the same cost of investment capital in times of market volatility.