Downside

What Is Downside?

Downside is the negative movement in the price of a security, sector or market. Downside can also refer to economic conditions, describing potential periods when an economy has either stopped growing or is shrinking.

How Downside Works

Downside is expressed in terms of an estimation of a security or economy's potential to experience negative movement. A stock analyst, for example, may forecast how far a stock price might fall because of certain events. Meanwhile, economists can predict the downside to a country's economy by taking into consideration factors such as the unemployment rate, inflation, and gross domestic product (GDP) growth.

Examples of Downside

Let's say an investor paid $100,000 to own 1,000 shares in Company ABC. Though unlikely, the stock price could potentially fall to $0, meaning the downside risk of the investment is 100% or $100,000.

That’s where calculating downside risk comes into play. In general, the higher the risk the greater the downside risk.

For most assets the downside is capped, as a price cannot go below $0. Exceptions include short selling, a trading strategy that enables investors to speculate on the decline of a stock or other securities price. If the price of an asset you shorted rises, you lose money. Moreover, your downside is theoretically infinite, as the price can keep on climbing.

Downside vs. Downside Risk

A movement to the downside is often expressed in terms of risk, such as the downside risk to a particular country's economy, or the downside risk to a company’s stock because of changing consumer trends. Downside is the potential negative movement, while downside risk looks to quantify that potential move.

For the most part, the higher the downside potential the greater the upside potential. This goes back to the idea of the higher the risk, the higher the reward. Upside is the positive move in an asset price.

Downside risk can be evaluated with fundamental and technical factors, estimating the amount a security or asset price might fall in the worst-case scenario. This can be done using probabilities or standard deviation models, although there is no way to perfectly estimate the downside unless some sort of downside protection is in place.

Downside Methods

Investors can protect themselves, or their portfolio, against downside by hedging losses. This is known as downside protection.

Downside protection provides a safety net if an investment starts to fall in value. This can be achieved in several ways, including:

Alternatively, investors might opt to wait out a market correction, hopeful that the stock will bounce back in the future.