ALL OF YOUR SEEDS (EGGS) IN ONE BASKET
A stock portfolio is subject to System Risk and Unsystemic Risk. Systemic Risk (market risk/un-diversifiable risk) are risks that all investors face and are not specific to any one company, segment, and so forth. A good example of Systemic Risk is the effect that changes in interest rates have on the stock market. Other examples may include acts of terror, war, natural disasters, political turmoil (eg: BREXIT or perhaps a decision/ruling that impacts the industry), and so forth. A stock’s volatility is a good measure of how the stock reacts to various systemic risk shocks. System Risk may be mitigated through hedging.
Unsystemic Risk (diversifiable risk) is specific to an individual company, market segment or industry. For example, General Motors may have unique business risks but also has risks associated with the auto industry. Business risk is a good example of an Unsystemic Risk because it can be somewhat mitigated through successful portfolio diversification. Regression Analysis is used to calculate a stock’s Beta (β) and Beta measures the stock’s volatility compared to the benchmark used (perhaps the industry index). Sometimes a zero risk asset is used for the benchmark (for example, a Treasury Bill). The “math” is:
β can be calculated in spreadsheet applications such as Excel. www.barchart.com is a free website for technical analysis that also has the β for the shares of many companies. I prefer using Excel as there is just something organic about entering the information and seeing how each new data entry affects the value. Because of a lack of history for many companies, be very careful on interpreting β. For example, how reliable is β for a JR Mining company recently converted to the legal cannabis industry?
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