Risks And Disadvantages Of Share Dealingindependent2020-09-09T12:13:37+00:00
The risks of trading shares are, in a nutshell, that you will lose your entire capital. Share trading can be lucrative and a broadly safe way to generate a return on your capital, but it can also be highly risky if you don’t know what you’re doing. There are risks inherent in trading in companies and on markets, and even doing business in a global economy poses threats beyond doing nothing. The trick is to learn how to analyse the risks of trading on a per transaction basis, so that you can make sure you’re trading with the right risk appetite for your portfolio.
How is risk calculated?
Risk is calculated by examining both the likelihood of damage occurring and the extent of the potential liability involved. A trade that is more likely to fail than another is by definition more risky for the trader, whereas a trade with a large capital investment will be more of a considerable risk than a small sized trade. Calculating risks requires a solid understanding of the probability of accuracy of your research, and consequently traders who want to be better a judging risks and making good trading decisions in the first place should ensure they are expertly knowledgeable about the markets and companies they wish to trade.
How can risk be minimized when trading shares?
Risks can be minimized in a number of different ways. Firstly, having a diversified portfolio means that the risks are spread across a number of individual share transactions, increasing the likelihood of adequate capital protection. The more positions you have open for your money, the less likely it is that they’re all going to fail, and arguably the more likely it is that you will profit on your deployed capital. Another way in which risks can be minimized in individual trades is through the use of stop loss orders, which set a guaranteed exit threshold at which shares traders can sell their positions. Stop loss orders provide valuable protection, particularly when used in rising markets to bank profits before a transaction has fully run its course.
What different types of risk are there?
There are a number of risks facing any trader, or anyone who exposes their capital to the financial markets. There’s market risk – the risk that the market may collapse during the period of holding your positions. There’s inflation risk – the risk that inflation may erode earnings through trading the markets. There’s credit risk, the risk that companies will default or become insolvent, not to mention political risk surrounding doing business in any worldwide economy. These different types of risk must always be considered by traders in deciding how to invest, and should be appropriately weighted to give an approximation of whether a particular investment is too risky.
The Cost of Brokerage
Another serious drawback of trading shares rather than other instruments is the cost of doing so. While shares are generally reasonably liquid (meaning narrower spread costs particularly in the FTSE and other large indices), the commission payable on share transactions often represents a comparatively substantial fee when compared to the costs of trading a spread betting position, for example. This means that in practice, share dealing is an expensive and comparatively low-yield investment type – something traders need to consider on a transaction-by-transaction basis in order to determine whether they are deploying capital in the most efficient way,
Because of the way shares are traded and the markets in which traders operate, larger transactional costs are the norm, often represented by a fixed fee portion of each transaction. While this does make share dealing more expensive for those on an individual scale, for example self-managing their life savings, these costs naturally become less of a per transaction burden as the capital amounts in question increase.
Potential For Huge Losses
As with most types of investment, the possibility for losses is always present with share dealing, and any dent in capital is both a hit on earnings today, and tomorrow. The potential for huge losses with share dealing is exacerbated by the fact that positions usually have to be held over a longer period of time to yield a profit, and the financial barriers to entry that exist in certain investments.
The base price of one share will determine the minimum exposure you can take in a market, and the risk of losing all your investment is never too far from view. As a result it is crucial to implement risk management processes and other means of controlling risk and potential trading threats in order to achieve optimum results. Furthermore, given the natural unpredictability of share markets, taking steps to protect your capital at every turn is wise in order to ensure longevity and your trading career over the long-term.