“Big risk yields big rewards.”
This quote is one of the commonest statements you would hear in the financial world.
This saying might have emanated from investments with some form of guaranteed returns, which makes sense. Unfortunately, this statement is not always true for day trading in a broader perspective.
The Volatility Factor
Stocks have higher returns and volatility when compared to bonds. This fact creates the impression that the bigger you go in, the bigger you earn. But this might be completely different in reality.
A very important factor you must also consider is that day trading doesn’t involve absolute returns and volatility. On the importance scale, your trade size outweighs your entry and exit when day trading stocks.
Your strategy might be efficient, but a large trade size puts you in a risk zone. Taking large trading sizes can blow your trading account quickly. Your position size is determined by how many shares you take on a trade.
Risk vs Volatility
Risk is split into two aspects, namely: the risk associated with your account and the risk associated with your trade. These two aspects are very important in terms of choosing an appropriate trade size. The risk associated with your account and the risk associated with your trade both converge on the volatility of the stock you engage in.
Many experienced traders try to avoid volatile stocks because volatile stocks are not stable. They can switch in any direction at any time.
It is advisable to put three things in check: your stop loss level, the resulting position size, and your risk tolerance level.
If you consider trading volatile stocks as a bumpy road, then smaller position sizes on stable stocks would minimize your risks and raise your chance of making profits.
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The Correlation Between Trade Size, Slippage, and Volatility
In the World Series of Day Trading, most mentors advised day traders to take it slow and small, especially for beginners.
Some emphasized that small spreads on large trading sizes can ruin your trading account easily.
Timing the market, getting the right fundamentals and technical analysis would be strong signs you must look out for in case you want to go in for a big trade size no matter how volatile the stock is.
Larger position sizes can be difficult to exit and it causes slippage. Slippage is when you get a different price than what you expected from an entry or exit.
Slippage is one main factor you must duly consider with high volatility stocks. When stocks become volatile, traders go into impulsive trading, piling up many stocks to get a quick profit.
This form of trading might work sometimes, but it puts the trader at a far greater risk. Don’t just buy a lot of stocks because they are cheap or their prices fell. In as much as you see this as a great opportunity, also take into consideration the fact that not every stock rises after the prices fall.
Some stocks can take months and even years to bounce back. Small trade sizes spread across consistent performing stocks is your sure bet for good earnings.
Your risk and reward parameters are what set the boundaries for your trading size. You can decide to go in for smaller trade sizes with large-stop loss or take large positions with smaller stop loss as a way of managing risk.
One of your main goals must be patience! Like a lion hunting a prey, wait for the right chance where the stop is small, pounce on it, and the reward would be good if everything works right.
The correlation between high volatility and returns should not be the only fundamental determinant in going in for trade sizes. Every single trade would have different parameters to assess risks.