Double your money or lose it all – either of this can happen when you deal with volatile stocks. Therefore, day trading or investing in such stocks should be done only after careful research and preferably after the completing good trading education classes from experts in the field. In order to make profits from volatile stocks, it is imperative that you understand the many challenges associated with such stocks. Read on to know more about them!
How to identify volatile stocks? Volatile stocks will have a wide swing in prices usually with high trading volumes, within a short period of time.
There are many issues associated with the investment in volatile stocks.
#1 Possible challenges to Company’s business model: One of the underlying reasons for the volatility could be the challenges faced by the company to its business model. For instance, the company’s heavy dependency on a single client, issues with finances during changes in interest rates, or presence of a competitor can make the company’s long term prospects a little sketchy. These underlying issues are reflected in the form of volatility in the stock prices.
#2 Price uncertainty: The volatility of a stock can last for years. A stock purchased at $50 may keep swinging between $25 and $40 for many years before it turns profitable. So, unless you are okay to endure such price changes for long-term, it is best to avoid volatile stocks for long term investment.
#3 Substantial trading capital requirements: Due to the volatile nature of stocks, many brokerage firms insist on a substantial trading capital for trading and investing.
#4 Margin issues for short positions: Many investors take short positions whenever they anticipate a bearish move. These short positions require margin money, thereby reducing your overall trading capital. Many volatile stocks end up with losses at the closing after committing large capital as margins.
#5 Overall profits could be lower: When holding volatile stocks over a longer time period, the overall profits gained from them could be lower due to inflation. On the other hand, lower risk corporate bonds or risk free treasury bonds can provide a nearly similar annual return without the high risks associated with volatile stocks.
#6 Sporadic dividend payments: Many investors look for dividend paying stocks to invest in for the long term. Volatile stocks usually do not pay consistent dividends, if at all. In addition, other corporate actions which increase prices, like rights issues, bonuses, or stock splits also happen quite rarely for volatile stocks.
#7 Investor participation not guaranteed: Thanks to their price fluctuations, the number of market participants and market makers may be limited in the case of volatile stocks. This puts long-term investors at a disadvantage.
#8 Disadvantages due to manipulations in price: The number of investors for a volatile stock is usually low. This makes them easier to manipulate by computer supported high frequency trading and algorithmic trading.
In addition to these challenges, there are also inherent risks associated with volatile stocks. Good trading education classes can help you identify these risks and navigate the pitfalls of volatile stocks. They can also aid you in picking out profitable volatile stocks with a good business model, competitive landscape, and market dependencies for day trading and investing.