Explainer · Risk, Costs & Protection
Stock market risk explained
Every stock can fall, and some fall to zero. This guide names the main kinds of stock market risk, shows the arithmetic of losses, and explains which risks you can reduce and which you cannot.
Quick answer
Stock market risk is the chance that your investment is worth less than you paid, or less than you need, when you sell. The SEC defines risk as uncertainty and potential financial loss [1]. Diversifying can help manage risk [4], but it does not stop the whole market from falling.
Key points
- You can lose money in any stock; there is no promise the company will grow [2].
- Large company stocks as a group have lost money on average about one year in three, according to the SEC [2].
- Losses need bigger gains to recover: a 50% fall needs a 100% gain to get back to even (calculated).
- FINRA says diversification can help manage risk [4]; it does not stop the whole market from falling.
- FINRA notes volatility can be a liability for money you need soon, such as for a house or a car [5].
On this page
What does risk mean when you buy a stock?#
The SEC's Investor.gov site defines risk as "the degree of uncertainty and/or potential financial loss inherent in an investment decision" [1]. For a stock, that means two things. The price you can sell at tomorrow is unknown, and it can end up below the price you paid.
A share of stock is a small piece of ownership in a company (see what is a stock). If the company does well, the shares may rise. If it struggles, they may fall. The SEC is blunt about the downside: there is no guarantee the company whose stock you hold will grow, so you can lose money you invest in stocks [2]. If a company goes bankrupt and is liquidated, common stockholders are the last in line to share in what is left [2].
What are the main types of stock market risk?#
Regulators sort risk into a few named types. The table summarizes the ones that matter most for a beginner who owns U.S. stocks. Sources: Investor.gov and FINRA.
| Risk type | What it means | Can diversifying help? |
|---|---|---|
| Market risk | Prices rise or fall because of market conditions | Only partly; the whole market can fall |
| Business risk | Company decisions or failure hurt the stock | Yes, by owning many companies |
| Volatility risk | The price swings even when the company is healthy | Partly |
| Liquidity risk | You cannot sell quickly at a fair price | Partly, by favoring heavily traded stocks |
| Concentration risk | Too much money in one stock or one basket | Yes, this is what diversifying targets |
| Inflation risk | Rising prices shrink what your money buys | Not directly |
Definitions from Investor.gov [1] and FINRA [4]. The last column is our plain-language summary of FINRA's statement that asset allocation and diversification can help manage both systemic and non-systemic risk [4].
FINRA splits these into two families. Systemic risk affects the economy as a whole, such as a broad market sell-off. Non-systemic risk affects a small part of the economy, or even a single company [4]. A corporate decision to merge or expand that goes wrong is one example of business risk [4]. Volatility is the day-to-day movement of prices, and FINRA notes that more dramatic swings mean higher volatility and potential risk [5]. Read more in our volatility and beta definitions.
How often do stocks lose money?#
More often than many beginners expect. The SEC's Investor.gov page on stocks says large company stocks as a group have lost money on average about one out of every three years [2]. That figure describes a broad group, not any single stock. One company can fall much further, or never recover.
The market also has emergency brakes for very bad days. Market-wide circuit breakers can halt trading when the S&P 500 falls 7% (Level 1), 13% (Level 2) or 20% (Level 3) from the prior day's close [6].
Why does a loss need a bigger gain to recover?#
Because the gain is measured from a smaller starting point. If $10,000 falls 50% to $5,000, a 50% gain only brings it back to $7,500. To return to $10,000 it has to double, a 100% gain (calculated). The formula is: gain needed = loss / (1 - loss). Try your own numbers with the percentage change calculator.
Which risks can you reduce, and which can you not?#
Investor.gov describes diversification as spreading money among different investments to reduce risk, summed up as "don't put all your eggs in one basket" [3]. FINRA says asset allocation and diversification can help manage both systemic and non-systemic risk [4]. Note the word "help". Owning many stocks reduces the damage one company can do. It does not stop the whole market from falling. Our guide to diversification covers how funds spread money across many companies.
Liquidity risk is the second one you can manage. FINRA notes that thinly traded investments often have wide bid-ask spreads, and you may have to accept a lower price to sell quickly, or in some cases not be able to sell at all [7]. Checking volume and average volume before you buy tells you how active a stock is.
- Decide when you will need the money
FINRA notes that for money needed soon, such as for a house or a car, volatility can be a liability [5].
- Know your risk tolerance
Investor.gov defines it as your ability and willingness to lose some or all of your investment in exchange for greater potential returns [3]. Ability and willingness are both part of it.
- Limit any single stock
Spread money across many companies and industries so one failure cannot sink the whole account [4].
- Check how easily you could sell
Look at volume and the bid-ask spread before you buy, not after [7].
Is keeping cash free of risk?#
No. Cash avoids price swings but carries inflation risk: Investor.gov notes that inflation reduces purchasing power [1]. In a hypothetical where prices rise 3% a year for 10 years, $10,000 held as cash would buy only what $7,440.94 buys today (calculated). The 3% rate is an example, not a forecast.
An investor with a longer time horizon may feel more comfortable taking on a riskier, more volatile investment [3].
Mistakes beginners make with stock market risk#
- Putting everything in one stock
A single company can fall far further than the market. FINRA calls this concentration risk [4].
- Investing money needed soon
A fall right before you need the cash can lock in a loss. FINRA warns volatility can be a liability for short-term needs [5].
- Selling in a panic
FINRA notes that when markets fall sharply, it is easy to react on impulse and sell [5]. Decide your plan before the drop.
- Thinking account protection covers losses
SIPC protection is for a failed brokerage firm, not for falling prices. SIPC does not protect against the decline in value of your securities [8]. See SIPC protection explained.
- Ignoring how hard it is to sell
Thinly traded stocks can be hard to sell at a fair price, or at all [7].
Frequently asked questions#
Can I lose all the money I put into a stock?
Yes. If the company fails, the shares can become worthless, and common stockholders are last in line in a bankruptcy liquidation [2].
Does diversification protect me from a market crash?
Not fully. FINRA says diversification can help manage risk [4], but it does not stop a market-wide fall. It mainly limits the damage any single company can do.
Is SIPC insurance against stock losses?
No. SIPC does not protect against the decline in value of your securities [8]. It helps when a member brokerage firm fails and customer assets are missing.
The bottom line#
Stock market risk is not one thing. It is the market falling, a company failing, a stock you cannot sell, too much money in one place, and inflation eating cash. You can reduce some of it by spreading money out, keeping short-term money out of stocks and checking liquidity. You cannot remove it. Next, see what trading really costs in brokerage fees and hidden costs, and read our risk disclosure.
Sources
Education only. This page is not investment, tax or legal advice. Stocks can lose value. See our risk disclosure.
