Day Trading

Written by Erin Jones
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It's important for investors to understand that day trading is risky. Risk is quantified by probabilities. The greater the likelihood of an outcome occurring, the less inherent risk. Most financial theory is structured around the above truisms. Unfortunately, lower risk does not necessarily translate into greater certainty in returns.

Lowering Total Risk by Day Trading

Oftentimes, common investors limit their investments and returns based upon the notion that risk is commensurate with returns. The greatest error in this idea is that it fails to combine individual risk with total risk. In other words, adding a riskier investment to your portfolio can actually lower your total risk more than if you added a "safer" investment. For example, if your portfolio is invested 100 percent in bonds, then adding another bond to your portfolio does not lower your total risk. In fact, it may increase your total risk. In the above scenario, it would make more sense to add a riskier vehicle, such as a stock, that will diversify your portfolio away from bond interest rate risk, and reduce your overall portfolio risk.

Many investors think myopically when adding investments to their portfolios. Additionally, they often make the worst decisions by adding investments that are performing well at that given moment. A general rule of thumb to follow is to let your time horizon dictate your investments, not the recent investment environment.

After defining your portfolio's total risk threshold based upon your time horizon, choose investments that will fit into your portfolio under your own rules. Constructing a portfolio is very difficult and many professionals rely on esoteric financial models. Most investors, however, can rely on historical relationships between stocks, bonds, real estate, and cash and be just fine. For the beginner, it may be a good idea to take course before starting to trade. Any quality program will teach you that proper diversification is always your best bet.

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