Stock trading activities can be a lot riskier than most people think. Before you start, it’s essential to know what some of these risks are and how you can limit them. Understanding the do’s and don’ts of stock trading will help you to build up a successful portfolio.
In stocks trading, there are an infinite number of possibilities that may affect your portfolio. It is easier to identify the risks of trading stocks by firstly identifying what makes a stock more or less risky. Riskier stocks are those with higher market volatility and lower market liquidity. These are factors that generally mean high spreads between bid and ask prices and much larger price swings.
High market volatility
A low-price range often measures market volatility over a given period; lower than average ranges indicate higher than average volatility and vice versa. Similarly, liquidity can be calculated as the inverse. Higher than average levels contribute to an increase in supply and can lead to bigger price changes for that reason, as well as because there are just simply more people willing to buy or sell that asset at any moment in time.
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It’s always best to diversify your stocks; it could limit the damage if one of your investments has a bad day. Let’s say you have one hundred shares in Company A and two hundred shares in Company B that are each worth $10/share when you bought them, if both go down to $5/share at some point during the year, then you’re still making money with 600 shares combined which are now worth $1000.
Another way to ensure less risk is through buying options instead of stocks directly. Options allow the buyers to protect themselves against losses without owning any stock or bonds. This means they can let their options expire even if everything goes south, so they don’t lose any money.
For most, there are better ways to invest than in stocks. If someone needs access to their investment funds within a few months or even years, it would be unreasonable for them to keep the money in stocks. It’s always best for people to put their spare funds in more stable investments like savings accounts, bonds, mutual funds, and other similar income-producing assets. Investment in these will ensure an increase in net worth over time.
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High-frequency trading algorithms
There are also hidden dangers that may arise when you’re investing at home. For instance, if someone uses a high-frequency trading algorithm with many different parameters, they could easily get overwhelmed by all of them. It can cause severe stress on their computer, which could ultimately lead to an outage and make it impossible for them to see the market’s trends.
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One last risk to consider is if you’re dealing with a margin account. This means that the broker has given you access to all of their money while only requiring you to put in a small percentage of your own. If you were trading with $100,000 instead of just $10,000, then this would be too risky because even if your investment were down 50%, it would still wipe out all of the broker’s funds which they could never get back, so they’d be forced to shut down their business.
With proper research beforehand, diversification, avoiding over-leveraging with options or margin accounts, and a backup plan if the market crashes, investors can significantly decrease their risk when trading stocks.
To learn more about how risky particular stocks are, we recommend trying out a Stock Market Simulator. It will allow you to get familiar with some of the risks associated with trading stocks without having to invest any real cash. It also teaches you how to leverage the benefits of stocks trading in your favour.