Day trading is when someone participates in buying and selling stocks or other tradable assets in a single day or several times a day. Day traders often make day trading their profession, as this type of trading is only profitable when it’s taken seriously and done in a professional and well-informed manner. Not everyone is suited for day trading, and there are several risks associated with this trading modality. Here we explore the risks of day trading and strategies to avoid them.
Risk #1: Depletion of Your Assets
Day trading can quickly deplete your assets if you’re not careful. Assets are the amount of money or capital that you’re willing to risk on a trade. To prevent an excessive loss of assets, a good strategy is to set aside funds you want to use when trading stocks and then set a budget on what you’re willing to risk from those funds. The most successful day traders typically risk less than 1% or 2% of their overall capital.
For example, if you have a trading account with $30,000 in it and you’re willing to risk 1%, this means the most you’ll lose on a trade is $300. Setting this budget can significantly reduce asset loss and keep you in the game.
Risk #2: The Lure of Penny Stocks
The lure of penny stocks is often strong when first starting out with day trading. These stocks often appear to offer low prices and quick deals, but the stocks themselves are usually illiquid, which means that the stock can’t be sold or traded for money without significantly losing its value. While penny stocks are certainly attractive at first glance, the chances of making money off them are low. The way to mitigate this risk is simple: avoid trading penny stocks.
Risk #3: Not Knowing When or What to Buy
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When first starting out in day trading, it can be tricky to know what and when to buy, and it may be tempting to jump the gun and just buy anything to get started. However, doing this can lead to a quick loss of assets and burnout. A good strategy for preparing to trade is to know what to look for. The following are the three things seasoned day traders look for daily:
- Trading volume: This is a measure of how often stock is bought and sold in a period of time. Trading volume is also referred to as the average daily trading volume. The higher the volume of a stock, the more interest there is in that stock.
- Volatility: Volatility refers to a stock’s anticipated daily price range. This price range is fundamental to a day trader as its the range in which they will operate. The higher the volatility, the greater the loss or profit.
- Liquidity: This term refers to how easy it is to enter and exit a stock while it’s at a reasonable price.
Day trading is not for the faint of heart, but with a good strategy in place and plenty of practice, you’ll be on your way to successful day trading.