Demystifying Stock Trading Risks, Part 1: Financial Troubles & Rumbles   

Demystifying Stock Trading Risks, Part 1: Financial Troubles & Rumbles   

What types of risk are associated with stock trading?

A wise man once said that anything that has value always carries its own set of risks. This old adage applies to stock trading, too. If you’re planning to earn an independent income stream from trading stocks, you need to be aware of all the risks involved with this type of investment system.

* Financial Troubles – Let’s face it, all publicly traded companies run the risk of losing money at some point in their lifetime. All corporations must come to an end, even if a corporation has been around for 100 years or more.

No one really knows when a publicly traded company will suddenly suffer from a strong financial blow. Economic recession, inflation, trade union activity – all of these factors come together to determine the life and robustness of a publicly traded company.

An interesting cautionary tale would be the DrKoop website which rose and floundered so badly in the mid-nineties that it was amazing how the founder was able to get more than 3 rounds of venture capital funding for it.

To cut this long story short, the DrKoop website (which attempted to ride the wave of DOTCOM fortunes of nineties) was able to amass several rounds of funding before it ran out of money.

In an effort to prevent it from going “belly up” when its primary reserves of funding completely ran out, it went public. 

Now, you would think that a company that had only generated only $40,000+ of revenue would be a bad idea to invest in, right? Apparently not. People flocked to buy DrKoop stocks and before the traders could react properly, the $20 stock did a fatal plunge to less than $3.

The company was able to negotiate a final round of external funding but it only delayed what was inevitable from the first day the DrKoop web service came into being. When the final round of funding had finally dwindled, the website closed and employees were of course laid off.

Day traders who committed the fatal mistake of blindly and greedily investing in DrKoop stocks learned that not every “high tech” company was going to be the next mega-stock and mega-fortune.

DrKoop was promptly delisted from the popular quotation service NASDAQ after it flopped and the founder, former Surgeon General Dr. Koop, continued his health advocacies well away from the DOTCOM landscape that he attempted to dominate.

The lesson here is simple: when a publicly traded company has absolutely no traction in relation to the size of its liabilities and external funding, you shouldn’t try to invest in its stocks. Doing so will only put your hard-earned money at a terrible risk for loss!

* Herd Mentality vs. Good Trading Sense – One of the dangers that beginning traders will encounter is the information overload associated with stock trading. At any one time, there are endless press releases, articles and magazine articles that tackle stock trading.

Stock speculation is the name of the game for many of the online media outlets and people can be very convincing with their stock speculations.

Pure speculation can be hidden under the guise of an innocent “stock tip”, which can be dangerous if a trader has a lot of funds but zero knowledge about trends, flags or even how to properly read price markers.

When rumors of a positive run causes a large mob of day traders to buy numerous shares of a specific stock without any prior research (as in the case of the busted DrKoop tech startup), that’s when herd mentality defeats good sense.

Investors are often afraid of being left out because let’s face it: it’s difficult to make any fast money from trading.

The average day trader only lasts for 3 years in the major markets, especially if the income from stock trading is relatively small compared to the fees and effort needed to trade properly.

This fear of losing out on a good run can create improbable spikes in the PPS of a stock.

This is the reason why you should be very careful when people are panic buying any kind of stock. Close your eyes and ears when everyone seems to be going in one direction – this type of trend is often caused by unfounded or poorly substantiated “stock tips”.

Research and solid data are your best friends when buying new stocks from an unknown company. Remember: the more volatile a stock, the higher the probability of losing your investment in the short term.

Read More: Demystifying Stock Trading Risks, Part 2: Interest Rates


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