The Risks of Trading Vs Investing

To be a player in the stock market, you are either an investor or a trader. There are risks associated with both. Here we discuss some of the risks unique to trading, vs investing.

The risks associated with trading increase as your trading volume increases. For example, day traders may incur more risks than position traders simply because they execute many more trades. Here are a few common risks associated with trading:

Trading Risk #1 - Slippage

There are hidden costs associated with every transaction. Slippage is just one of them. It is the cost of trading based on two components. The first is the commission cost of executing your trade. The second involves getting your buy filled at an unfavorable price. For example, if you put in a buy order at a certain price, but it gets filled at a slightly higher price, this is referred to as slippage. You've paid a bit more for your shares than you initially wanted.

Whenever you enter a trade, you may be subjecting yourself to the problem of buying at the ask price, but selling at the bid price. The ask price is the lowest available for your preferred stock. The bid price is the highest price that someone is willing to pay for your stock. The bid price is usually lower than the ask. As your number of trades increases, the amount of money you lose to slippage also increases.

Trading Risk #2 - Poor Execution Risk

There may be times where your order cannot be filled right away. Sometimes your broker may have a problem executing your order for any number of reasons. In these cases, the price you may be expecting can be quite different than the price you may actually be receiving.

Trading Risk #3 - Risk of Gaps

Gaps are a risk that you take if you hold positions overnight. They can occur intraday, but this is a very rare occurrence. They can occur when the opening price gaps higher or lower than the previous day's close. For example, let's say you bought a stock at $30, and placed a stop at $27. The the next day the stocks opens at $25, which means it gapped down, over-shooting your $27 stop. Instead of losing $3 per share, you have now lost $5 per share.

Trading invariably comes with unique risks. If you have a solid game plan, and account for worst case scenarios with various costs and monetary risks, you can still be successful as a trader.