Greater Profit Comes With Greater Risk. | ASXnewbie.com

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Weekly Ramblings of an Australian Stock Trader – incorporating ASXweekendtrader.com
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Greater Profit Comes With Greater Risk.

by strudy1

Just for something different instead of talking about trading basics we will go into some other avenues for the more experienced traders amongst you.

For the more experienced  traders, using margin trading, selling short, moving into  IPOs, and more advanced trading techniques and other strategies can open up a completely new world of stimulating trading experiences  for you, and ultimately could achieve you greater potential profits.

So saying that, let us tackle one subject at a time.

Firstly understanding IPOs

IPOs or initial public offerings as they are called, is when a company changes over from a privately owned organization to a publicly held firm.

Almost every incorporated business issues common shares, although at the start this is usually to a few select stockholders. Usually this is for a company to raise the necessary capital required, without having to incur any debt. The most commonly method used  is to sell stock to the general public, thereby they then become a publicly traded company.
There are mainly two basic ways to potentially make money from these IPOs.

Firstly and most importantly , the trader needs to get in very early and buy the stocks through the initial public offering. What the trader is banking on is a large quick rapid increase in the share price. And of course if this occurs the trader then sells these shares for a nice quick profit.

The other alternative  method is for the trader to sit back, and watch and wait until after the IPO has commenced. Then if the new stock is fairly priced and reasonable, then one could then purchase the stock.

Then it is a waiting game in the hope the stock will rise as time progresses.

Remember that with IPO’s you are relying on the stock price rising quickly to achieve those quick profit.

Shorting Stocks.

This is a well known and very much published way of trading. Selling short is an advanced technique that numerous traders do not capitalize on. Short sellers seek the best stock available to sell.

Short sellers are selling stock they don’t actually own with a belief the value will reduce downwards by a significant amount in the very near future. These shares are borrowed from a stockholder. The borrowing is done by each party’s brokers.

The basic idea is that when the share price tumbles, the short sellers can then buy back the stock at the lower price to cover their short positions, pocket the profits and then hopefully return the shares to the original owners.

Short selling can be extremely risky though, because if the share prices go upwards instead of dropping, you will definitely lose money. It is of course frequently very difficult to accurately predict whether a stock will fall.

Taking a  historical view, the actual tendency of the average stock is to increase in price over the long term. So this means that the potential for loss is far greater than the potential for profit. This is because the short seller is going against the odds  trying to gamble against a known historical average.

Margin Trading

Margin Trading is when the trader opens an account which  allows the trader to borrow money to purchase stock. Margin traders uses this borrowed money to increase the amount of stock the trader can buy. This money can be loaned by either a broker or a bank.

Normally if you were to buy a stock worth $1,000 on a cash basis, without the use of margin trading, you would have to pay the full $1,000 dollars, plus any  commissions that were due.

But when you margin trade, your broker can lend you up to half of the amount or $500 on many stocks (or possibly more), and you only need to pay the other $500 plus commissions and interest payments.

This is called leverage.

We will now presume that  the stock has risen by $5 per stock, the profit made would be based on the number of shares of stock you bought with $1,000. Then you would pay the broker back and keep the difference.

If you did not margin trade, your profit then would only have been for the number of shares of stock you paid for using cash.

On the other hand, were the stock price to unfortunately go down, the loss incurred would be based on the entire $1,000, and you would still owe the margin loan amount to the broker.

You would in this scenario be getting a urgent request from a broker or dealer for additional funds, (A margin call) or other collateral to guarantee performance on a position that has moved against the trader negatively.

In closing as with everything in life, there is always  an opposite face to every coin. In numerous cases, the bigger the profit, the greater the risk level rises.

Advanced trading is not for the faint of heart or the inexperienced trader , and realistically you should only trade with risk capital, and not with money that you can’t manage without.

I wish you every success in your future trading. :-)