25 May 2016

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. 

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