Definition of 'Downside Risk'
An estimation of a security's potential to suffer a decline in value if the market conditions change, or the amount of loss that could be sustained as a result of the decline. Downside risk explains a "worst case" scenario for an investment, or how much the investor stands to lose. Some investments have a finite amount of downside risk, while others have infinite risk. The purchase of a stock, for example, has a finite amount of downside risk; the investor can lose his or her entire investment. The sale of a stock, however, as accomplished through a short sale (or "selling short") entails unlimited downside risk, since the price of the security could continue rising indefinitely.
Investopedia explains 'Downside Risk'
Investors, traders and analysts use a variety of technical and fundamental metrics to estimate the likelihood that an investment's value will decline, including historical performance and standard deviation calculations. In general, many investments that have a greater potential for downside risk also have an increased potential for positive rewards. Investors often compare the potential risks associated with a particular investment to its possible rewards.
Downside risk is in contrast to upside potential, or the likelihood that a security's value will increase.