Dubai: When you’re new to stock market investing or trading (buying or selling) shares real-time, buying into the latest ‘hot’ stock can seem like a good way to get started, but trying to profit from short-term changes in a stock price can carry a great deal of risk.
The traditional way to deal with putting resources into the stock market includes, ‘buy and hold’, wherein stocks would be purchased and held for weeks, months, or even years. In short-term exchanging, stocks are for the most part bought and held for a couple of minutes or hours.
How can you profit from a small short term price movement? The answer lies in mastering what is referred to as ‘active trading’. But how does one profit when a stock’s price changes in a brief period?
Let’s say you turn a profit on a quick trade. What’s your next move? Can you consistently pick winners?
Relying on market's unpredictability for profits
Short-term trading uses the market's unpredictability to make profits in the most extreme way. While it can be a good way to earn money, and many do it as a profession, but to succeed in short-term trading, it is important to have in-depth insights into how the markets function.
“A significant way short term trading differs from traditional ‘buy and hold’ approach is, here the focus is only on price action or how the prices move instead of focusing on the long term outlook on the stock,” said Brody Dunn, an investment manager at a UAE-based asset advisory firm.
“Let’s say you turn a profit on a quick trade. What’s your next move? Can you consistently pick winners? Not only is it difficult to try your luck again and turn a profit by trying to time the market, but short-term gains might be small in comparison with what a long-term holding could be worth.”
Next trading move after making a quick profit?
When you hear of a trend-setting stock whose price is sky-rocketing, you may be tempted to believe you could be nimble enough to dart in and out with a gain. In reality, however, by the time you hear about the ‘hot’ stock, you may have missed out on easy gains – and risk buying high.
This is when fear of missing out (FOMO) surfaces for a newbie investor. “The fear of missing out, or FOMO, has led many people to buy into ‘hot’ investments, and it may lead unwary investors to lose bundles of money,” added Dunn.
“Not only can FOMO cloud judgment, it can also overshadow logic, which is problematic when making trading decisions. However, the real FOMO to consider is the prospect of missing out on the long-term returns of holding the shares of a great company in a thriving industry.”
What’s more, the risk of losing some or even all of your money is very real. This is why high-risk investments are unsuitable for all but experienced investors who fully understand both the risks and the opportunities associated with these investments.
Why speculate on how assets will perform?
Often times, the investors experienced in short-term trading do it because they could potentially earn a higher return. “But if you do not have an appetite for such risk or you don’t need to even do that, why would you do it?” asked Zubair Shakeel, a UAE-based asset manager.
“Moreover, if you’re in it for the long haul, your investments are already on course for success,” he added. “While investing in stocks, bonds and other asset classes too carries some risk — but it’s a calculated risk that generally has a historical track record of success over long time periods.”
Shakeel tells his clients who are adamant about holding a risky asset that they should generally limit their position to a low-single-digit percentage of their overall holdings and they shouldn’t invest with money they’ll need in the near or intermediate term, he said.
Verdict: Why investing for quick gains isn’t prudent
There are chances that you may lose a significant amount of money while indulging in short-term trading due to the volatilities in the share markets. Short-term investing also comes with high costs due to a high transaction volume and their corresponding brokerage commission fees.
At first glance, new investors may also find cheap stocks to not only be affordable, but a way to make a quick profit. With as little as Dh100, you can get a lot more shares in a cheap stock than a stock that might cost Dh50 a share. Plus, you gain more if a low-priced stock goes up by a dirham.
What such stocks offer in potential profitability has to measure against the volatility that they face. These stocks are cheap for a reason – they are poor quality companies that, more often than not, will not work out profitability. Losing even 50fils on such a stock could mean a 100 per cent loss.
“If you believe that a stock's price will rise, go for a long trade. If you think it will fall, a short trade will let you profit from that price movement. However, for most investors, long trades will generally be the better way to go. They're less risky, and shorting stocks can be complicated,” added Shakeel.