There are risks to everything you do. For example, where you choose to live…
If you choose to live in Florida, you may be taking the risk of getting your house blown down by a hurricane. On the flip side, if you choose to live in California, you may have earthquake risks.
However, that doesn’t stop 38 million people from living there! The point is: there are risks to everything you do – whether it be choosing where to live or trading in the stock market.
A trade risk is what you put on the trade. For example, if you put $1000 on a trade, that is your trade risk.
The market risk is different from the trade risk. The market risk describes what can happen to the market.
For example, a war may break out in Greece or Spain. Or there may be a catastrophic event that affects the debt ceiling. Something that happens to the global economy, your current country, etc. all represents the market risk…
Margin risk only happens if you’re borrowing money – if you’re borrowing money on margin.
If you’re trading and putting on a regulation account and using current funds you have available, that is fine and dandy. However, borrowing money from a broker (ex: buying a house) and not paying back the money in a set amount of time leads to margin risk…
Eventually these debts will catch up to you, and you will have to pay the money back and close your positions. Otherwise you will be forced to do so.
I don’t typically have liquidity issues, because I trade stocks that are trading heavily with very liquid companies. If you’re trading with Apple, Netflix, etc. in the current time – you’ll be fine.
However, if you’re trading penny stocks (stocks trading for less than a couple dollars a share), you may have liquidity problems.
That’s why the hedge funds, the money-makers, and the big institutions don’t trade low-dollar stocks. They need liquidity – they need to be able to get in and out of companies quickly.
If you’re not able to get out of companies quickly when needed, the stock is not liquid which makes it difficult. You may be forced to hold on to a position that is tanking.
If you’re a day-trader holding that stock from the morning of the opening bell to the closing of the opening bell, you do not have overnight risk…
However, if you’re a long-term holder, investor, or swing-trader – you may have overnight risk if you hold a position overnight or for multiple days. You don’t know what will happen overnight. You don’t know what will happy to the company, what news will come out, what will happen overseas, etc.
For example, a company that sells car products may have an engine explosion in China causing the stock to crash the next day (your stock would change overnight).
Volatility is the range or magnitude the stock is moving in.
For example, larger companies that are priced at $300-$500 per share might move up or down $7-$10 in one single day. It shakes people out!
For stocks that are only $20 per share, it may only move up or down $1 in a day’s time at most. Many people feel safe with this option because it doesn’t scare them. It’s less volatile.
Think of volatility as the range, not the direction. It implies the magnitude of the move (up or down).
There are trade-offs with each type of risk. For example, if you want to avoid margin risks that’s fine. However, you may want to take part in margin risks if you’re having a killer year to up your earnings.
Now that you know the 6 market risks, trade accordingly. You can’t eliminate all the risks, but you can avoid some of the risks if you choose to.