As the name may suggest, the concept of downside risk looks at the financial risk associated with losses.
It measures the potential loss in value of an investment in adverse market conditions and can detail a worst-case scenario for an investment to give you an idea of how much you could stand to lose.
Rather than focusing on the potential gains, the benefit of looking at the likelihood and extent of potential losses ensures that you are making fully informed decisions when managing your portfolio.
By assessing the downside risk, you can start to implement strategies to mitigate potential losses, such as diversification, or setting stop-loss orders.
This risk management approach helps protect your investment portfolio during market downturns, with the ultimate goal of helping to establish long-term financial stability.
It is of course important to keep in mind that this measure is only one-sided as downside risk does not address the potential profit, though it can be a useful tool in balancing one's risk tolerance with their financial goals, aiming for a more personalised risk-reward ratio.