Systematic Risk

Understanding Systematic Risk

Systematic Risk, often referred to as market risk or non-diversifiable risk, is the risk that affects the entire market, not just a single stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It is an essential aspect to consider when it comes to trading.

Causes of Systematic Risk

Several factors can contribute to systematic risk. These include economic factors such as inflation, interest rates, and recessions. Other large-scale events such as wars, political instability, or natural disasters can also create systematic risk. In essence, any event or condition that impacts the entire market can be a source of systematic risk.

Systematic Risk and Trading

In the realm of trading, systematic risk is of significant concern. Traders cannot protect themselves from it through diversification since it impacts the whole market. For example, if the entire economy is going through a recession, even a diversified portfolio may suffer losses. Traders and investors use various strategies such as hedging or investing in safe assets to minimize the effects of systematic risk.

Measuring Systematic Risk

The common way to measure systematic risk is with beta. A beta of one indicates that the security's price will move with the market. A beta less than one indicates the security will be less volatile than the market. A beta greater than one indicates the security's price will be more volatile than the market.

Managing Systematic Risk

While it is impossible to avoid systematic risk completely, measures can be taken to manage its impact. Diversifying investments across different asset classes, geographic regions, and industries can help. Also, hedging strategies using options or futures can protect against downside risk.