Understanding
the Risks of Day Trading
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What are the Risks in Day Trading?
While Day Trading has emerged as
a wildly popular phenomena, it's risks should not be underestimated.
Arthur Levitt, Chairman of the Securities
and Exchange Commission issued a statement to investors on
January 27, 1999 concerning the risks of on-line trading.
In his statement, he encouraged investors to not lose sight
of what he referred to as the "three golden rules for
all investors":
1. Know what you are
buying.
2. Know the ground
rules under which you buy and sell a stock or bond.
3. Know the level
of risk you are undertaking.
Mr. Levitt stressed in his communication
that investors often don't realize the speed at which the
market can move. Many investors are caught off guard by rapid
price movements and get trapped in losing positions. The increasing
tendency of investors to buy securities on margin was also
a concern. Leveraged investment positions can lead to catastrophic
losses if the market turns against you.
The National Association of Securities
Dealers, Inc. (NASD) Board of Governors echoed Mr. Levitt's
concerns as it issued its "NASD Regulation to Solicit
Comment on Proposed Rules for Day Trading Activities"
on March 25, 1999. In an effort "to ensure that investors
are better informed about the risks involved before engaging
in high-risk investment activities like day trading"
the NASD issued a proposal that prospective day traders be
fully educated on the potential risks of their activities.
These disclosures, according to the NASD should include at
a minimum the following points:
1. That day trading
can be extremely risky.
2. That customers
be cautious of claims of large profits from day trading.
3. That day trading
requires knowledge of securities markets.
4. That day trading
requires knowledge of a firm's operations.
5. That day trading
may result in large commissions.
6. That day trading
on margin or short selling may result in losses beyond the
initial investment.
While the potential rewards for
successful day trading can be impressive, the risks are substantial.
No one should enter the day trading arena with money that
he or she cannot afford to lose. If you believe that Day Trading
is for you, just make sure that you go in with your eyes wide
open and with a full understanding of the risks involved.
What
are the Capital Requirements of Day Trading?
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