Simple Ways to Measure Stock Risk for a given month and put Stop-Loss and Take-Profit correctly.
- Sanzhi Kobzhan
- Jun 10
- 11 min read
Updated: Jun 29
Table of contents:
Why it's not possible to measure stock risk accurately.
Stock market risk or just a market risk, can sometimes be labeled as uncontrollable risk by market professionals. Because you cannot really measure it accurately, eliminate it, and can't tell exactly how much you can lose when it comes to holding a stock. Of course, you can lower your risk by using different portfolio management models or derivative instruments, but you cannot fully eliminate the market risk. This is because there are so many factors that come into play when it comes to market risk. For example, if the company is posting better-than-expected earnings, its stock price can go higher, but no one cancelled the speculative capital that can significantly affect trading patterns; moreover, no one knows when larger players will start selling, this can lead to the stock going lower. No one can accurately forecast those events which lead to higher unpredictability. But you still can count market risk somehow. Yes, it won’t be very accurate, but at least you will have a clearer picture of what your stock's trading range can be on the longer term. In this article, I want to explore different options on measuring stock risk so that you can understand better what you are buying and avoid stocks that can lose in value a lot. Also, I will be focusing on portfolio risk, a portfolio that consists of stocks and how you can measure your possible portfolio loss.
How you should not measure your risk.
A lot of beginner investors and traders think that volatility or standard deviation is a good measure of market risk. Yes, volatility can be a good approximation of your stocks’ movements, but it is a good shorter-term measure and it is not the best market risk measure since it’s not counting company-specific events such as a company's net cash flow, operating margins, or economic events such as the inflation rate or the cost of money. Simple volatility is also not the best when it comes to measuring the portfolio risk. Volatility gives you an approximation of what your stocks’ deviation from the mean can be, based on vintage (historical) analysis, but you should not rely on volatility when it comes to assessing portfolio market risk or a single stock risk on the longer-term scale. Let's consider some other options of measuring market risk (stock risk).
Option 1: Measuring market risk through the cost of money.
Cost of money tells you what the cost of borrowing and lending money is. When the cost of money goes up, businesses borrow money at a higher rate. This affects their profitability and strategies. This has a direct effect on the share price, as higher cost of money increases company spendings (costs) and leads to analysts lowering their estimates, which in turn leads to lowering the target price of the stock. This has a direct effect on the share market price, as traders start selling the stock when they see that analysts turn pessimistic about the stock. Lower cost of money, on the other hand, promotes businesses, as they can borrow at a lower rate and then reinvest money supporting their product or service. This will lead to businesses posting revenues better than analysts expect and at lower costs. This will lead to higher revenues and EPS, better than analyst estimates, boosting the share price. Cost of money can be tracked by examining Money Market rates (REPO rates). These are the rates at which banks borrow money from each other. Then, they put in a certain margin and charge higher rates for businesses when lending them money. When the cost of money does rise, mainly through REPO transactions or currency SWAPs, banks have difficulty lending money and they try to accumulate them. This pushed them to increase the rate at which they lend money to the businesses. Falling REPO rates, on the other side, make the cost of money cheaper. REPO rates usually go higher when the central bank makes the interest rate higher. The central bank rate is the rate at which it can borrow and lend money to the commercial banks.
Now let's see how to measure the risk in this case. You need to examine the overnight repo rates. This is the rate at which banks can borrow money for 1 day, in exchange for bonds as collateral. Then, in 1 day, they should return the money and get their bonds. If you examine the rate, the most recent data shows 5.37% (For the US) as shown on the picture below.
Of course, if you have a Bloomberg terminal, you get fresh data undated daily, but monthly data is also good as it gives you a rough approximation. The next step is to take the inflation rate for April (if you are trading the US stocks, you need the US inflation data) as shown in the below picture and deduct it from the MM rate. 5.37% - 2.30% in our case, and we get 3.07%. This is the potential risk that you are bearing for investing in assets in April. Of course, individual stocks can have higher downside probability, but if your investment portfolio, that consists of stocks, exceeds that potential loss of 3.07%, it’s time to rebuild your portfolio and put other stocks or maybe change stock weights to lower its portfolio risk.
Now how you can calculate possible loss for a single stock? It's simple, multiply 3.07 by stocks Beta and you will get your expected loss. For example for AAPL share with Beta 1.21 the loss expectation is 3.71%.
Option 2: Measuring market risk through the market risk premium.
The Market Risk Premium is the extra return you expect from investing in the stock market compared to a safe investment like government bonds, showing how much more reward you might get for taking on the stock market's risk. In a simple terms, if you invest in risky assets like stocks, you want higher returns compared to the risk free assets like US treasury bonds. And this market premium shows how much extra return you should require from investing into stocks. This risk premiums differs from country to country, more stable countries have lower risk premiums. When you get needed premium (for your chosen country) subtract it from the inflation rate to get your possible stock portfolio loss. First let me explain how to get market risk premiums and then we will proceed to the calculations.
To get data on premiums, you can use the Financial Modeling Preps Market Risk Premium API endpoint. Simply get your custom API key to use the endpoint and paste the below line to the browser's address bar, replacing the "custom_api_key" words with your actual API key.
after replacing the key and pasting the above line into your browsers address, you will have a JSON formatted data that looks similar to the picture below
Find your desired country, The United States in your example, and you will have a 4.33 equity risk premium. Now deduct 2.3% inflation rate that you got in the prevous step, and you get 2.03% expected portfolio's loss for a given month. As you can see this option provides lower number and you can choose yourself which option to choose in assessing possible loss.
For calculating a loss for a single stock multiply 2.03 by the Beta which trandslates into 2.45% in the case of AAPL share.
Option 3: Measuring market risk through the US treasury yields.
These are US Treasury bond yields. Simply take the yields across different maturities, sum them up, and divide by the number of bond issues. For example, in my case, I need to sum up 4.38, 4.36, 4.34, and so forth and divide by 14 since it’s 14 different maturities as shown in the below picture. And we get 4.20%. Now deduct the inflation rate, and you get 1.9%. This is your expected portfolio loss based on the 3rd option.
To calculate expected loss for a single stock, multiply this number by the stock's beta, the same way as we did with the previous options. As you can see, this is the lowest number so far, but this is not always the case . I would recommend that you take the highest number among the five options provided and use it as your possible risk benchmark.
Option 4: Measuring market risk through the Value-At-Risk (VAR).
Value-at-Risk (VaR) is a tool that estimates the maximum amount of money you could lose on an investment over a specific time with a given level of confidence. For example, if a stock portfolio has a 1-day VaR of $1,000 at 95% confidence, it means there's a 5% chance you could lose more than $1,000 in one day. It helps investors understand potential risks, like if a $10,000 investment in a tech stock has a 1-month VaR of $2,000, indicating a 5% chance of losing more than $2,000 in a month. VAR can also be calculated for a portfolio of assets.
I've written a detailed guide on how to calculate a VAR for a single stock and for a portfolio of stocks, you can get this guide by reading my article "How much money can you lose by investing in stocks".
You can also watch my video tutorial on calculating portfolio’s risk using the VAR model
Option 5: Measuring market risk through the stock’s target prices.
This method is for a single stock. Stock target prices are estimated stock prices based on company's financials forecasts calculated by different investment analysts. The stock target price is a good indication of market risk because analysts forecast a company's free cash flow with their custom assumptions, such as the cost of capital and the inflation rate, when calculating the stock target price using the DCF model. By comparing the current market price with the target price, traders can understand what the stock’s growth potential (the difference between the fair value and the market value of the stock) is. Yes, this growth potential itself is not the market risk, but it can be used to derive the market risk. First, let me show you how to extract stock target prices calculated by different investment analysts. And then I will show you how to derive the market risk for your individual stock using the stock target price method.
For extracting stock prices, we would need a financial modeling prep (FMP) endpoint and Google Sheets. Get your custom API key with FMP and follow the instructions to connect Google Sheets with FMP. After that, go to any empty cell inside the Google Sheets and use this formula "=fmpPriceTarget(A2)" where A2 in my example is the stock ticker AAPL. You can put the AAPL in the A2 cell or just type it inside the formula manually. After that, hit the enter button, and you will get stock target prices as shown in the below picture.
You can see analyst names and their price targets. Take the most recent price target, which is $250 in the case of AAPL. Current AAPL's market price as of June 9th is $201.45, which implies 24% growth potential for AAPL shares. In theory, analysts can reconsider their calculations quarterly (every 3 months), so this number can change very soon.
Now let’s see how much the AAPL share gained/lost in the past 3 months. As we can see from the below picture, AAPL lost 15.46% in the past 3 months. Ignore the minus sign, now simply deduct $15.46 from the 24% growth potential, and you get 8.54%, and now divide this number by 3 since we are interested in monthly possible loss. And we get 2.84% as AAPL's possible monthly loss. Another example: If you have a stock growth potential of 10% and a return in the past 3 months of 30%, for example, still deduct 30 from 10, and you get -20%. Ignore the minus sign, and you get just 20%, then divide it by 3, and you get 6.6% possible monthly loss.
This is how you can calculate your possible stock loss for a given month.
Another simple way of calculating the stock monthly expected loss using the stock target price method is to use the Stocks 2 Buy iOS app. If you use this method, you don't have to download stock target prices to Google Sheets or do different manual calculations. Let’s see how to use this option and let’s analyze the OVV stock as an example. Download the Stocks 2 Buy app, register, log in, and go to the Stock Type screen as shown in the picture.
Input the stock ticker (OVV in our case) and hit the Analyze button. The app will show you the stock type and when the best time to buy your chosen stock is.
Also, the app shows the Piotroski score, which is 8 in the case of OVV stock, indicating that this stock is strong fundamentally. But we are interested in the stock growth potential (target price exceeding its market price), which is 25% for OVV stock, and a 3-month return is 12.35%. Now, subtract 12.35 from 25 and divide by 3, and you will get 4.21%. This is the monthly expected loss for OVV stock.
Setting the Stop-Loss and Take-Profit.
A stop-loss is an order to automatically sell a stock when its price drops to a set level, helping to limit potential losses if the market turns against you. A take-profit is an order to sell a stock when it reaches a predetermined price, locking in gains before the price might fall. These tools are important because they help investors manage risk and secure profits without needing to constantly monitor the market, providing discipline and protection in volatile conditions.
Since you already know how to calculate your expected monthly loss, you can choose one of the methods that best suits you and put the stop loss accordingly. I would choose the target price method, that shows a 2.84% loss for the AAPL share. If we take the current AAPL price of $ 201.45 as of the 9th of June, the Stop-Loss will be $195.72. This is how we calculated it:
Stop-Loss: $ 201.45 - 2.84% = $195.72
Now let’s calculate our monthly take profit for the AAPL share. Multiply the possible expected loss (2.84 without the minus sign) by 2 since we want to have a profit at least two times higher than our loss and add it to the current market price. The number 5.68% from the below calculation is calculated by taking 2.84% expected loss percentage (without the minus sign) and multiplying it by 2.
Take-Profit: $201.45 + 5.68% = $212.89.
You can also set the Stop-Loss and Take-Profit based on stock's standard deviation, but this method only takes historical stock price movements without considering stock targets with analyst assumptions. However, if you are interested in setting the stop-loss and take-profit using the standard deviation approach, you can use the Stock Analyzer Chrome extension.
Additional methods and considerations:
You can also use the Monte Carlo simulation for assessing your risk, but this model gives you the range for your possible losses. I would recommend applying all those methods at the same time and then coming up with the average number among all the methods listed. By doing this, you will come up with the smoothed number of your possible risk, when it comes to both a single stock and a portfolio of assets. Please keep in mind that it is not possible to make accurate forecasts as no one knows what will happen in the future, but thanks to the mentioned options, we can get a rough approximation of what your loss can be, and you can shape your investing strategy accordingly. If you want to lower risk, you should consider using derivative instruments or building an efficient investment portfolio using the Markowitz model. Thanks for reading my article. I hope it was useful.
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