Question

How can risk be assessed in equity?

Answer 1

Equity risk is the financial risk due to holding equity in one's portfolio.

The most common measure to assess the risk involved in equity is the standard deviation of returns which is nothing but a statistical concept that finds out the fluctuation in returns around the average returns from an equity over a period of time. The greater the value of standard deviation the higher shall be the risk involved in the equity. This is because it shows how volatile the returns from an equity investment would be and no investor in their right mind would want to invest in an equity that has highly volatile returns unless he has an enormous appetite for risk.

Also, risk can be assessed by the assessment of the current market price of the equity or forecasted future price. This is done with the help of two most important school of thoughts prevalent in the present day world of finance. These are fundamental and technical analysis.

Fundamental analysis is based on the assessment of the financial statements of a company that one is interested in. It helps in assessing the intrinsic value of an equity and shows whether the fundamentals of a company support the current market price of the company's stock or not. When the intrinsic price of a company's equity is more than the prevailing market price then shares or equity of a company is believed to be underpriced and hence it is a good bet for an investor. However, if it's the other way round then risk in the equity is huge.

Technical analysis believes that the market price of a stock incorporates all fundamental information and hence helps in forecasting the future price of equity based on historical trends in price movement. Investors investing in equity always face the risk of decline in the price of their equity due to price changes and hence would like to overcome this risk. Technical analysis is one way of assessing this risk and taking appropriate measures to avoid such a loss due to price change.