Volatile stocks can be very rewarding for the savvy trader allowing quick profits from day trading.
However, these stocks can become your worst nightmare if you don’t fully know what you are getting into.
In this post, we’ll explain what volatile stocks are and whether it is safe for you to hold them overnight.
Ready? Let’s get started.
What is considered a volatile stock?
In financial markets, volatility refers to changes in a security’s or market’s price especially as compared with a benchmark or its normal behavior.
Therefore, a volatile stock is a stock that simply fluctuates in price more than other stocks and is considered to be highly risky.
Volatile stocks are often regarded as riskier due to their less predictable performance.
Volatility is generally reported as a percentage.
For example, if a stock is ranked 30%, this means it is likely to either gain or lose 30% of its total value. The bigger the percentage, the more volatile the stock.
Volatility can also be measured by looking at the stocks Beta.
Beta basically measure a stocks volatility compared to the overall market.
So a stock with a beta of 1 indicates the stock is trading with the market while a beta over 1 shows the stock is more volatile than the over all market. If the market sells off, you can expect that stock to sell off even more.
A beta under one represents a stock that isn’t very volatile. Utility stocks or defensive stocks typically have a beta of less than one.
Risks of holding volatile stocks overnight
An overnight position simply refers to any position held after the closing bell.
When trading volatile stocks, some day traders, especially new ones, do the mistake of holding the stocks overnight. Sometimes the mistake is unintended, and other times it is deliberate but not well thought out.
Volatile stocks have the potential to change prices rapidly, allowing a trader who jumps on the right side of the price change to earn a quick profit.
However, one thing you need to know about volatility is this: the more volatile a stock is, the riskier it will be.
That is why we discourage our students from holding volatile stocks overnight because these stocks can gap against you a lot causing large losses.
Such unforeseen dramatic moves may be caused by things like disappointing earnings results, CEO resignation, or bad economic releases.
This is an unnecessary risk, especially for new traders with limited capital.
How margin can drastically impact overnight holdings
Margin trading, borrowing capital through your broker to buy and trade stocks, is a crucial part of every trader’s toolkit.
Buying stocks on margin allows traders to significantly increase the returns from their trades, as well as create profitable trading strategies and opportunities that would otherwise not exist.
Generally, you must first complete an application process that has to be reviewed by your stockbroker to make sure you are eligible for a margin account.
Similar to the way you apply for a bank loan, your broker will examine your net worth, annual income, credit history, and estimated liquid net worth to gauge whether you are financially capable of managing a margin account.
For margin accounts, you must maintain a minimum balance of at least $2,000 but you will be offered 2 to 1 leverage, which means if you have $2,500 in the account you will have up to $5,000 in buying power.
However, it is usually not a good idea to hold volatile stocks overnight especially if you are using margin because margin involves extra risk.
Even if you believe that a volatile stock will continue in your favor after the market close, try as much as you can to avoid holding it, particularly if you don’t have enough capital to cover the potential losses or margin.
Additionally, don’t be the trader who tries to make up losses by holding his/her positions overnight, hoping that the stock will move back in their favor the next day.
There is no guarantee that the stock will turn back around.
Imagine buying shares of stock XYZ at the end of the after-hours trading session on Monday. Later in the night, a presidential tweet says that U.S. has ended its trade talks with China.
Next thing you know, XYZ opens Tuesday’s pre-market session down 30%. Unless you’ve a lot of trading capital, why risk such an event?
Focus on trading during normal hours
The term normal/regular trading hours refers to the standard stock exchange hours of operation.
Normal trading hours for the U.S. stock market, including the Nasdaq Stock Market (Nasdaq) and the New York Stock Exchange (NYSE) are 9:30 a.m. ET to 4:00 p.m. ET on weekdays (excluding stock market holidays).
In some cases, typically the day before or after a market holiday, normal stock trading ends at 1:00 p.m. ET.
As mentioned earlier, traders can also buy or sell stocks in the pre-market (4:00 a.m.-9:30 a.m. ET) and after-hours market (4:00 p.m. ET – 8:00 p.m. ET), but the largest numbers of trades are made during normal hours.
Trading during extended hours used to only be available to large institutional investors. However, it is now available to retail traders thanks to computerized executions.
While it is possible to trade outside of the normal market hours, it’s a risky endeavor because there are significantly fewer individuals trading during these extended hours, which can have a massive effect on prices, particularly those of volatile stocks.
Having far fewer people trading can also have a huge effect on the liquidity of a stock. With so much less volume, it can be more difficult to buy and sell volatile stocks in exchange for a liquid asset such as cash.
Therefore, focus on trading during normal hours to avoid these risks. Be cautious about price movements in the pre- and postmarket.
Keep in mind that extended trading hours only represent a small percentage of the overall market sentiment.
What the price does during normal market hours might be completely different than in extended sessions. Don’t assume that a stock’s trend will continue outside the normal trading hours.
Day trading volatile stocks can be risky if you don’t exercise caution.
But if you do your research, and avoid the common pitfalls of a volatile market, you may find great opportunities among the turbulence.
Trend carefully and trade small until you learn the ropes and are confident in your abilities to trade these types of stocks.