What is market risk?
Share risk can be split into two parts. One is a company’s own risk: management mistakes, demand for a product drying up, an accident at a factory. The other is market risk: events that hit almost all companies at once, such as a recession, rising interest rates, a pandemic or panic across the market.
Owning many companies’ shares can reduce much of the first kind, because the same mishap does not strike every company at once. But however many shares you buy in the same market, the second kind remains. That is why it is also called “undiversifiable risk”.
When heavy rain falls on Dhaka for several days, almost every rickshaw puller in the city earns less, however skilled. One person’s rickshaw breaking down is their own problem; the rain is everyone’s problem. The share market is the same: bad news about one company is its own risk, and a shock to the whole economy is market risk.
Why it matters to an investor
- To see the limits of picking good companies: research can reduce company-specific risk, but it cannot protect you from a market-wide fall.
- To see the limits of diversification: even with 20 shares, if they are all in the same market, almost all of them can fall together in a big crash.
- To see why shares are expected to pay more: in finance theory, investors expect a higher long-run return than deposits in exchange for bearing risk they cannot avoid. Expected does not mean guaranteed.
- To see the danger of borrowing: buying shares with a margin loan multiplies the loss when the market falls, and your shares can be sold off without your choice.
Where it comes from, and how big it can be
- The economy: in a downturn, sales and profits fall, so almost all companies’ share prices come under pressure.
- Interest rates and inflation: when rates rise, deposits and bonds become more attractive, and companies’ borrowing costs go up.
- Global shocks: on 19 October 1987 (“Black Monday”) the US Dow Jones index fell 22.6% in one day, and the fall spread to markets around the world. In the 2007–09 global financial crisis, the S&P 500 fell 57% from its October 2007 peak to its March 2009 low.
- In Bangladesh: during Covid, trading on both the Dhaka and Chittagong stock exchanges stopped from 26 March 2020 with the general holidays and restarted on 31 May 2020, after 66 days. Good company or bad, no share could be sold in that time. The big fall of 2010–11 is covered in the “Types of risk” lesson.
Beta: how much a share swings with the market
Beta measures how much a share tends to move with the market. A beta of 1 means the share has moved about as much as the market on average. A beta of 1.5 means about one and a half times as much, and 0.5 about half as much. Beta is calculated from past prices, changes over time and does not hold every day; it is a rough guide.
Market risk cannot be removed entirely, but there are common ways of living with it: spreading money across other kinds of assets besides shares (asset allocation), not keeping money needed soon in shares, not buying with borrowed money, and holding a separate emergency fund so you are not forced to sell in bad times.
Worked example
- Say your Tk 1,00,000 is split equally between two shares: Tk 50,000 in share A (beta 1.5) and Tk 50,000 in share B (beta 0.6).
- The market falls 20%. Going by beta, share A would fall roughly 1.5 × 20% = 30% (Tk 15,000) and share B roughly 0.6 × 20% = 12% (Tk 6,000).
- The estimated total loss is Tk 21,000, about 21%. The portfolio’s beta is (1.5 + 0.6) ÷ 2 = 1.05. The numbers are only an example.
Result: changing which shares you hold can raise or lower your portfolio’s beta, but you cannot bring market risk to zero with shares alone. And the real loss can differ quite a lot from the beta estimate.
Common mistakes
- Thinking “it’s a good company, so it won’t fall even if the market does”. In a big fall, good companies’ shares usually fall too.
- Assuming many shares means no risk, even though they are all in the same market.
- Buying shares with borrowed money or a margin loan, so a market fall does even more damage.
- Treating beta as an exact measure. It is a past average, not a promise about the future.
However good the shares you pick, you cannot fully escape a wave that hits the whole market; the real question is how big a wave you can ride out.