Industry risk analysis assesses the risks of investing in a specific industry by examining real-world events and charting price movements. It helps investors diversify their portfolios and avoid being too biased towards a single sector, which could be detrimental if industrial risk materializes.
An industry risk analysis is performed by an investor or investment professional determined to show the risks involved in investing in a specific industry. The idea behind such an analysis is that different companies in the same industry are often related in terms of stock performance and the risks their particular industry poses. Performing an industry risk analysis involves looking for real-world events that could hurt a particular industry and charting price movements to account for any significant downtrends. Furthermore, the analysis can focus on an investor’s portfolio to ensure that he is well diversified and immune to most of the risks in the industry.
Many people study their stock selections by analyzing each potential stock and the companies that issue them. Such a strategy may overlook the kind of risks a company takes based on just the industry in which it lives. This is known as industrial risk and is significant enough that it could alter the fortunes of any company. Given that this is the case, it is wise for investors to consider an analysis of industry risks when building their portfolio.
As an example of how industry risk works, imagine a company in the technology sector dedicated to a specific product. If another company adopts improved technology that makes this product obsolete, the company could be in dire financial straits, and their stock price would reflect that. A sound risk analysis would consider this type of risk when valuing such a company.
Industry risk analysis can be done with technical analysis techniques similar to those used for individual stocks. The only difference would be that these techniques, such as price charts and moving averages, would be applied to industry averages. In this way, price developments can show whether an industry is heading towards decline. Using this type of analysis in conjunction with qualitative analysis of current events that could cause turmoil in some industries will provide a comprehensive overview of an industry’s risk factors.
One way that an analysis of sector risk can help an investor is by demonstrating whether their portfolio is too biased towards a single sector. Such a scenario could be detrimental if the industrial risk surrounding that industry materializes and stock prices collapse. Balancing a portfolio with stocks from various sectors with varying levels of risk can help stave off such a calamity.
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