Let’s begin at the beginning:
What is a risk?
A risk is an opportunity to gain or lose.
In trading, you have risks when entering a trade [loss] and when exiting a trade [profit/loss]. There are also risks of holding on to a position [e.g. stop loss] despite adverse market movements [profits or losses]. If you have positions open in any time frame – day trading or swing/position trading, there will most likely be some type of risk attached.
However, this is not always the case, and many traders will hold positions overnight and simply close them out before market opening (referred to as ‘day-trading’). If you’re new to trading, it’s hard to know what level of risk vs reward is appropriate for the stock you’re trading. So far, we’ve learned that a stock’s direction and momentum plays a big part in determining if a stock is suitable for day trading or swing/position trading. Each stock has its own set of factors that affect its profit-and-loss potential, called stock indices.
Advice on volatility and risk
It’s best not to pick up stocks that only have minor signs of upward momentum because there is too much risk involved. If you simply buy every stock that shows some positive trend, you’re going to incur losses and experience stock drawdowns [losses]. What’s more important when trading is knowing when not to trade is called position sizing or money management.
Before we get ahead of ourselves – let’s go over a few things:
Three main factors determine stock price movement:
- Risk (volatility of stock movement)
- Reward (potential stock price increase)
- Time Frame (there is less risk involved with holding on to a position the longer the time frame)
Let’s inspect each of these dynamics. We’ll be using the daily chart again, as it gives us an overview of stock prices on a larger scale. Remember that we can also apply this information to any other time frame you’re trading – whether that’s day trading, swing/position trading or investing. By knowing how these three dynamics work, you will know what type of stock offers better opportunities for day trading than others. You will see potential stock-price movement, as well as knowing when stock prices are too high, and there is considerable risk involved.
Let’s begin with one of the most critical factors:
Risk (volatility of stock movement)
There are two main types of stock volatility:
- Upward Volatility – When a stock price increases over time (the stock can be bought and sold at higher prices than what you bought it for)
- Downward Volatility – When a stock price decreases over time (the stock can be bought and sold at lower prices than what you bought it for)
Stocks that experience upward volatility will usually have an uptrend [as seen on the daily chart] where stock prices increase incrementally over time. Stocks that experience downward volatility will usually have a downtrend [as seen on the daily chart] where stock prices decrease incrementally.
How to tell if stock prices are too volatile?
If stock prices move up or down by over 10% in one day, it is considered very high risk, and you should not trade this stock until there is a relief of some sort (this relief could be caused by an upcoming earnings report, for example).
Start with a demo account
If you are new to stock trading, it is advisable to open a demo account to practice your new trading analysis and strategies before entering a real-money trade. Choose a demo account on a reputable broker’s platform. You will also have access to countless news resources and educational materials to help you enter the stock trading market more safely.
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