Most of the risk in trading stocks derives from the possibility of large price fluctuations resulting from an unexpected event or an unforeseen news item. These include a change in day trading stock picks, financial or political crises, market announcements, company bulletins, sector information, analyst recommendations, and rumors.
Statistics show that you can expect at least three market meltdowns during your own lifetime. Here are some examples of major crises that have roiled the markets in the past:
- The stock market crash known as the Great Crash began on Black Monday, October 28, 1929, with a 12.8% drop in the Dow Jones Industrial Average, followed the next day with an 11.73% drop. The crash led to a 10-year economic slump known worldwide as the Great Depression.
- Herd panic ruled the day on October 19, 1987. The crisis commenced in Hong Kong, spread to Europe, hit the United States, and caused the Dow to drop 22.8% in just one day, marking the greatest ever single-day drop for the index.
- The dot-com bubble burst on Monday, March 13, 2000, following five years of sharp rises. On that Monday, the market opened with a gap of 4% down on the Nasdaq index as institutional investors simultaneously sold shares in Cisco, IBM, and Dell at a value of billions of dollars. The drop ignited a wave of sellers, leading eventually to a loss of 9% over the next six trading days
- The credit crunch, more commonly known as the subprime crisis, burst onto the American market in the summer of 2007 and developed into an overall worldwide economic crisis. The crisis intensified in September 2008 with the collapse of Lehman Brothers investment bank and the nationalization of American International Group insurance company. The panic peaked in October and November 2008, during which the market lost some 30% of its value.
Less Market Exposure Reduces Risk for Day Traders
Because no one can anticipate the timing or impact of such events, the best way to reduce risk is to reduce market exposure time.
During such crises, market fluctuation and trade volume increase. If you’re a medium- or long-term investor who holds stocks for weeks, months, and years, there’s a reasonable chance that you’ll lose a sizeable portion of your capital during such events. That’s one of the greatest risks for medium- or long-term investors, but it is a risk largely avoided when you become a better day trader.
Day Traders Assume Less Risk than Investors
When faced with the same conditions of market fluctuation and increasing trade volume during market crises, experienced day traders flourish, but beginner day traders might run into more trouble because of their lack of experience. Because day traders operate with large numbers of shares, they exit most of their transactions during the trading day. Swing traders buy smaller quantities and are, therefore, more willing to accept the risk associated with a trade lasting several days. But even swing traders will try to sell 75% of their holdings as early as possible to reduce the risk of exposure to market mood shifts. And unlike the majority of the public, day traders and swing traders know how to profit from drops by mastering the principles of shorting.
In summary, holding stocks means taking risks. Experienced day traders and swing traders assume less risk than investors because of their reduced exposure to the market. The more knowledge a day trader has gained, whether through a day training academy or speaking to a day trading mentor, will lead to wiser decisions in the case of a market crisis.