What Is Systematic Risk and How May It Affect Markets?
Systematic risk affects all traders, no matter the strategy or asset class. It comes from market-wide forces—like interest rates, inflation, or geopolitical shifts—that influence entire sectors at once. Unlike unsystematic risk, it can’t be avoided through diversification. This article breaks down what systematic risk is, how it’s measured, and how traders may incorporate it into their analysis.
What Is Systematic Risk?
Systematic risk refers to the kind of risk that affects entire markets or economies, rather than just individual assets. It’s the result of large-scale forces—like inflation, interest rates, central bank policy, geopolitical conflict, or economic slowdowns—that ripple through multiple asset classes at once.
A sharp rise in interest rates, for example, tends to push bond prices lower and can drag down equity valuations as borrowing costs climb and consumer spending slows. Similarly, during a global event like the 2008 financial crisis or the COVID-19 shock in 2020, almost all sectors saw simultaneous drawdowns. These events weren’t tied to poor management or bad earnings reports—they were macro-level shifts that hit everything.
Because it’s a largely undiversifiable risk, systematic risk is a key consideration for traders assessing overall market exposure. It often drives correlation between assets, particularly in times of stress. This is why equities, commodities, and even currencies can start to move in the same direction during periods of heightened volatility.
So, can systematic risk be diversified against? Only relatively speaking. Traders and investors may shift into defensive positions to limit potential drawdowns (e.g. gold, bonds, healthcare stocks vs tech companies). However, no matter how diversified a portfolio is, it remains exposed to this kind of risk because it’s tied to broader market movements rather than asset-specific events.
Note: systematic risk differs from systemic risk. The systemic risk definition relates to the potential collapse of the financial system, such as in a banking crisis. It is rare but severe.
Systematic vs Unsystematic Risk
Systematic risk is broad and market-driven. Unsystematic risk, on the other hand, is specific to a company or sector. It might come from a product failure, a major lawsuit, or a change in management. For example, if a tech company misses earnings due to poor execution, that’s unsystematic. If the entire sector drops because of a global chip shortage or policy change, that’s systematic.
Unsystematic risk can be reduced through diversification. Holding assets across industries may help spread exposure to isolated events. But systematic risk can’t be avoided by simply adding more assets. It affects everything to some extent.
That’s why traders track both systematic and unsystematic risk—understanding where their risk is concentrated and whether their exposure is tied to broad market movements or individual events. Clear separation of the two may help traders analyse potential drawdowns more accurately.
Key Drivers of Systematic Risk
Systematic risks tend to stem from structural or macroeconomic forces, and while they can’t be avoided, traders can track them to better understand the environment they’re operating in. Below are some of the most common types of systematic risk and how they influence market-wide movement.
Monetary Policy
Central banks play a huge role in shaping market conditions. When interest rates rise, borrowing becomes more expensive, which tends to slow down spending and investment. That usually puts downward pressure on risk assets like equities. Conversely, rate cuts or quantitative easing often lead to a surge in asset prices as liquidity improves.
Traders closely monitor central bank statements and economic projections, especially from institutions like the Federal Reserve, the Bank of England, and the European Central Bank.
Inflation and Deflation
Inflation affects everything from consumer behaviour to corporate earnings. Higher inflation can reduce real returns and push central banks to tighten policy. Deflation, though less common, signals weak demand and falling prices, which also tends to hurt equities. Commodities, currencies, and bonds often react sharply to inflation data.
Economic Cycles
Booms and busts are among the most well-known examples of systematic risk, influencing everything from job creation to earnings growth. During expansions, risk appetite tends to rise. In downturns, investors often shift towards defensive assets or cash. GDP figures, manufacturing data, and consumer spending are key indicators traders watch.
Geopolitical Risk
Elections, wars, trade tensions, and sanctions can drive sharp market reactions. These events introduce uncertainty, increase volatility, and can disrupt global supply chains or investor sentiment.
Market Sentiment and Liquidity
Panic selling or sudden shifts in positioning can cause assets to move together, even if fundamentals don’t support it. During liquidity crunches, correlations spike and markets can move sharply on little news. This is often driven by leveraged positioning unwinding or large institutions adjusting risk.
Measuring Systematic Risk
Systematic risk can’t be removed, but it can be measured, and that may help traders understand how exposed they are to broader market swings.
One of the most widely used tools is beta. Beta shows how much an asset moves relative to a benchmark index. A beta of 1 indicates that the asset typically moves in the same direction and by a similar percentage as the overall market. Above 1 means it’s more volatile than the market; below 1 means it’s less volatile. For example, a high-growth stock with a beta of 1.5 would typically move 15% when the market moves 10%.
Another approach is Value at Risk (VaR), which estimates the potential loss on a portfolio under normal market conditions over a specific timeframe. It doesn’t isolate systematic risk but gives a sense of how exposed the overall portfolio is.
Traders also watch the VIX—often called the “fear index”—which tracks expected volatility in the S&P 500. When it spikes, it usually signals rising market-wide risk.
More complex models like the Capital Asset Pricing Model (CAPM) use beta and expected market returns to price risk, but some traders use these tools to get a clearer picture of how exposed they may be to movements they can’t control.
How Traders May Use Systematic Risk in Analysis
Systematic risk isn’t just a background concern—it plays a direct role in how traders assess the market, structure portfolios, and manage exposure. By understanding how market-wide forces are likely to affect asset prices, traders can adjust their approach to reflect broader conditions rather than just focusing on technical analysis or individual names.
Position Sizing and Exposure
When systematic risk is elevated—during tightening cycles, political unrest, or global economic slowdowns—traders may scale back position sizes or reduce leverage. The aim is to avoid being caught in a correlated sell-off where multiple positions move against them at once. It's common to see increased cash holdings or a shift towards lower beta assets in these periods.
Asset Allocation Adjustments
Systematic risk also shapes how capital is distributed across asset classes. For example, during periods of strong economic growth, traders may lean into equities, particularly cyclical sectors. In contrast, during uncertain or contractionary periods, there may be a move towards defensive sectors, fixed income, or commodities like gold. Some rotate between assets based on macro trends to stay aligned with the dominant forces driving markets.
Macro Analysis and Scenario Planning
Understanding systematic risks may help traders prepare for potential market reactions. A trader can analyse upcoming interest rate decisions, inflation prints, or geopolitical tensions and assess which assets are likely to be most sensitive. If recession risk increases, they may expect higher equity volatility and reassess exposure accordingly.
Correlation Tracking
As systematic risk rises, correlations between assets often increase. Traders who normally count on diversification may find their positions moving together. Keeping track of these shifts may help reduce false confidence in portfolio structure and encourage more dynamic risk controls.
Systematic Risk: Considerations
As mentioned above, systematic risk is mostly unpredictable and fully unavoidable. There are some other things you should consider when trying to analyse it. Here are a few points traders often keep in mind:
- Lagging indicators: Metrics like GDP or inflation are backwards-looking. Markets often react before the data confirms the trend.
- False signals: Beta, VaR, and the VIX can be useful, but they’re not foolproof. A low VIX doesn’t guarantee calm markets, and beta doesn’t account for real market conditions.
- Uncertainty around timing: Even if the presence of risk is clear, the timing and severity of its impact are hard to analyse with precision.
- Overreaction risk: Markets can price in fear quickly, and traders may misjudge whether a reaction is justified or temporary.
- Diversification assumptions: Assets that usually behave differently may move in sync during stress. Risk models can underestimate this.
The Bottom Line
Systematic risk is unavoidable, but understanding how it moves through markets may support traders in making decisions. By tracking macro drivers and adjusting positions accordingly, traders may respond with more clarity during volatile periods. However, it is important to take into account all the difficulties that systematic risk brings.
FAQ
What Is Systematic Risk?
Systematic risk refers to the type of risk that affects an entire market or economy. It’s driven by macroeconomic forces such as interest rates, inflation, economic health, and geopolitical events. Because it impacts broad segments of the market, systematic risk cannot be eliminated through diversification.
What Is Systematic Risk vs Unsystematic Risk?
Systematic risk is market-wide and linked to broader economic conditions. Unsystematic risk is asset-specific and tied to events like company earnings, leadership changes, or industry developments. According to theory, unsystematic risk can be reduced by holding a diversified portfolio, while systematic risk remains even with strong diversification.
What Are the Five Systematic Risks?
The main categories include interest rate risk, inflation risk, economic cycle risk, geopolitical risk, and currency or exchange rate risk. Each can affect multiple asset classes and contribute to broad market shifts.
Can You Diversify Systematic Risk?
No. While diversification may help reduce unsystematic risk, systematic risk affects most assets. It might be managed, not avoided.
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
Systematic risk affects all traders, no matter the strategy or asset class. It comes from market-wide forces—like interest rates, inflation, or geopolitical shifts—that influence entire sectors at once. Unlike unsystematic risk, it can’t be avoided through diversification. This article breaks down what systematic risk is, how it’s measured, and how traders may incorporate it into their analysis.
What Is Systematic Risk?
Systematic risk refers to the kind of risk that affects entire markets or economies, rather than just individual assets. It’s the result of large-scale forces—like inflation, interest rates, central bank policy, geopolitical conflict, or economic slowdowns—that ripple through multiple asset classes at once.
A sharp rise in interest rates, for example, tends to push bond prices lower and can drag down equity valuations as borrowing costs climb and consumer spending slows. Similarly, during a global event like the 2008 financial crisis or the COVID-19 shock in 2020, almost all sectors saw simultaneous drawdowns. These events weren’t tied to poor management or bad earnings reports—they were macro-level shifts that hit everything.
Because it’s a largely undiversifiable risk, systematic risk is a key consideration for traders assessing overall market exposure. It often drives correlation between assets, particularly in times of stress. This is why equities, commodities, and even currencies can start to move in the same direction during periods of heightened volatility.
So, can systematic risk be diversified against? Only relatively speaking. Traders and investors may shift into defensive positions to limit potential drawdowns (e.g. gold, bonds, healthcare stocks vs tech companies). However, no matter how diversified a portfolio is, it remains exposed to this kind of risk because it’s tied to broader market movements rather than asset-specific events.
Note: systematic risk differs from systemic risk. The systemic risk definition relates to the potential collapse of the financial system, such as in a banking crisis. It is rare but severe.
Systematic vs Unsystematic Risk
Systematic risk is broad and market-driven. Unsystematic risk, on the other hand, is specific to a company or sector. It might come from a product failure, a major lawsuit, or a change in management. For example, if a tech company misses earnings due to poor execution, that’s unsystematic. If the entire sector drops because of a global chip shortage or policy change, that’s systematic.
Unsystematic risk can be reduced through diversification. Holding assets across industries may help spread exposure to isolated events. But systematic risk can’t be avoided by simply adding more assets. It affects everything to some extent.
That’s why traders track both systematic and unsystematic risk—understanding where their risk is concentrated and whether their exposure is tied to broad market movements or individual events. Clear separation of the two may help traders analyse potential drawdowns more accurately.
Key Drivers of Systematic Risk
Systematic risks tend to stem from structural or macroeconomic forces, and while they can’t be avoided, traders can track them to better understand the environment they’re operating in. Below are some of the most common types of systematic risk and how they influence market-wide movement.
Monetary Policy
Central banks play a huge role in shaping market conditions. When interest rates rise, borrowing becomes more expensive, which tends to slow down spending and investment. That usually puts downward pressure on risk assets like equities. Conversely, rate cuts or quantitative easing often lead to a surge in asset prices as liquidity improves.
Traders closely monitor central bank statements and economic projections, especially from institutions like the Federal Reserve, the Bank of England, and the European Central Bank.
Inflation and Deflation
Inflation affects everything from consumer behaviour to corporate earnings. Higher inflation can reduce real returns and push central banks to tighten policy. Deflation, though less common, signals weak demand and falling prices, which also tends to hurt equities. Commodities, currencies, and bonds often react sharply to inflation data.
Economic Cycles
Booms and busts are among the most well-known examples of systematic risk, influencing everything from job creation to earnings growth. During expansions, risk appetite tends to rise. In downturns, investors often shift towards defensive assets or cash. GDP figures, manufacturing data, and consumer spending are key indicators traders watch.
Geopolitical Risk
Elections, wars, trade tensions, and sanctions can drive sharp market reactions. These events introduce uncertainty, increase volatility, and can disrupt global supply chains or investor sentiment.
Market Sentiment and Liquidity
Panic selling or sudden shifts in positioning can cause assets to move together, even if fundamentals don’t support it. During liquidity crunches, correlations spike and markets can move sharply on little news. This is often driven by leveraged positioning unwinding or large institutions adjusting risk.
Measuring Systematic Risk
Systematic risk can’t be removed, but it can be measured, and that may help traders understand how exposed they are to broader market swings.
One of the most widely used tools is beta. Beta shows how much an asset moves relative to a benchmark index. A beta of 1 indicates that the asset typically moves in the same direction and by a similar percentage as the overall market. Above 1 means it’s more volatile than the market; below 1 means it’s less volatile. For example, a high-growth stock with a beta of 1.5 would typically move 15% when the market moves 10%.
Another approach is Value at Risk (VaR), which estimates the potential loss on a portfolio under normal market conditions over a specific timeframe. It doesn’t isolate systematic risk but gives a sense of how exposed the overall portfolio is.
Traders also watch the VIX—often called the “fear index”—which tracks expected volatility in the S&P 500. When it spikes, it usually signals rising market-wide risk.
More complex models like the Capital Asset Pricing Model (CAPM) use beta and expected market returns to price risk, but some traders use these tools to get a clearer picture of how exposed they may be to movements they can’t control.
How Traders May Use Systematic Risk in Analysis
Systematic risk isn’t just a background concern—it plays a direct role in how traders assess the market, structure portfolios, and manage exposure. By understanding how market-wide forces are likely to affect asset prices, traders can adjust their approach to reflect broader conditions rather than just focusing on technical analysis or individual names.
Position Sizing and Exposure
When systematic risk is elevated—during tightening cycles, political unrest, or global economic slowdowns—traders may scale back position sizes or reduce leverage. The aim is to avoid being caught in a correlated sell-off where multiple positions move against them at once. It's common to see increased cash holdings or a shift towards lower beta assets in these periods.
Asset Allocation Adjustments
Systematic risk also shapes how capital is distributed across asset classes. For example, during periods of strong economic growth, traders may lean into equities, particularly cyclical sectors. In contrast, during uncertain or contractionary periods, there may be a move towards defensive sectors, fixed income, or commodities like gold. Some rotate between assets based on macro trends to stay aligned with the dominant forces driving markets.
Macro Analysis and Scenario Planning
Understanding systematic risks may help traders prepare for potential market reactions. A trader can analyse upcoming interest rate decisions, inflation prints, or geopolitical tensions and assess which assets are likely to be most sensitive. If recession risk increases, they may expect higher equity volatility and reassess exposure accordingly.
Correlation Tracking
As systematic risk rises, correlations between assets often increase. Traders who normally count on diversification may find their positions moving together. Keeping track of these shifts may help reduce false confidence in portfolio structure and encourage more dynamic risk controls.
Systematic Risk: Considerations
As mentioned above, systematic risk is mostly unpredictable and fully unavoidable. There are some other things you should consider when trying to analyse it. Here are a few points traders often keep in mind:
- Lagging indicators: Metrics like GDP or inflation are backwards-looking. Markets often react before the data confirms the trend.
- False signals: Beta, VaR, and the VIX can be useful, but they’re not foolproof. A low VIX doesn’t guarantee calm markets, and beta doesn’t account for real market conditions.
- Uncertainty around timing: Even if the presence of risk is clear, the timing and severity of its impact are hard to analyse with precision.
- Overreaction risk: Markets can price in fear quickly, and traders may misjudge whether a reaction is justified or temporary.
- Diversification assumptions: Assets that usually behave differently may move in sync during stress. Risk models can underestimate this.
The Bottom Line
Systematic risk is unavoidable, but understanding how it moves through markets may support traders in making decisions. By tracking macro drivers and adjusting positions accordingly, traders may respond with more clarity during volatile periods. However, it is important to take into account all the difficulties that systematic risk brings.
FAQ
What Is Systematic Risk?
Systematic risk refers to the type of risk that affects an entire market or economy. It’s driven by macroeconomic forces such as interest rates, inflation, economic health, and geopolitical events. Because it impacts broad segments of the market, systematic risk cannot be eliminated through diversification.
What Is Systematic Risk vs Unsystematic Risk?
Systematic risk is market-wide and linked to broader economic conditions. Unsystematic risk is asset-specific and tied to events like company earnings, leadership changes, or industry developments. According to theory, unsystematic risk can be reduced by holding a diversified portfolio, while systematic risk remains even with strong diversification.
What Are the Five Systematic Risks?
The main categories include interest rate risk, inflation risk, economic cycle risk, geopolitical risk, and currency or exchange rate risk. Each can affect multiple asset classes and contribute to broad market shifts.
Can You Diversify Systematic Risk?
No. While diversification may help reduce unsystematic risk, systematic risk affects most assets. It might be managed, not avoided.
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.