Smart investing entails knowing how to manage the probable risks. There exists 3 dissimilar investment risks that you should protect against for any investment you make, be it a stock, mutual fund or bond. These three types of risks associated with investment are business risk, evaluation risk and force-of-sale risk. You can find out about all of these types of risk from stock market books or by reading on. The stock market can be tricky so make sure your trading software is sufficient.

Among the types of investment risk, business risk is probably the most common and the most easily understood type. Basically, it refers to the probability of losing the value of a stock or any investment because of negligence, rivalry with other stocks, and financial collapse. There are some businesses that are inclined to greater degrees of business risk. Examples of these industries include airlines, railroads, and the like.

Having a franchise value is the best defense against business risk.The presence of a franchise value allows companies to increase prices to adjust for augmented taxes, labor or costs for materials needed. A franchise value does not apply to any investment made under a commodity-type business and therefore, such an investment faces a substantial loss of value whenever the market's financial atmosphere turns south.

To help you understand more easily the second type of investment risk, I will be using examples. Let us say that just recently, I have come across a company that I was completely impressed with. Its growth is stellar, margins are outstanding, minimal or zero debt on the balance sheet, and it is expanding into several new markets. However, the price I must pay to trade with this company is so far in excess of the amount of its present and average profits. I cannot find a good reason why I should buy the stock.

The business risk is not what I am worried about. Rather, I am concerned about the evaluation risk. In order to validate purchasing a stock at this excessive price, I must be 100% sure that the growth probabilities in the future will increase the amount of my earnings to a more desirable degree than all of the other investments I have.

The fact that there is usually not much room for error in companies that seem overvalued is exactly the reason why there danger in investing in them. Such a business may appear superb, but if it goes through a significant decline in sales in even just one quarter or if it is not able to begin new locations as quickly as it initially predicted, the stock will experience a hefty decline. Never ask a question that goes “Is this company a wise investment?” but ask something like, “Is this company a wise investment at this price?”.

Now, let us discuss the last type of investment risk—the force-of-sale risk. Let us say that you have located a business that is performing outstandingly, with a trading price that is a lot lower than its actual worth, buying quite a few shares. It is now February and you intend to use the investment to fund for the payment you need for your tax bill on April. By doing so, you have committed a fatal mistake in the world of investing. It is okay to be relatively sure of what is going to happen, but it is never okay to be relatively sure of WHEN it is going to happen. Never be certain that your financial analysis will take place when you think it will.