This article was originally drafted to discuss overnight risk. But the volatility we have seen in stocks over the past year shows that TradingMarkets Trading Rule #6 is equally applicable for traders looking to minimize corporate risk – by which we mean the potential for any one stock position to have a disproportionate impact on a portfolio of stocks. We present this rule in that spirit as well.
Equities are the backbone of the U.S. economy and most of us were raised trading stocks. But, stocks have more risk than indices, ETFs, Holdrs, and iShares. Here’s why.
Let’s look at two extreme examples. The first is with Biogen, a large, well established Fortune 500 company.
In February 2005, ^BIIB^ voluntarily withdrew its new Multiple Sclerosis drug because two patients on the drug (at that time) passed away and their deaths were linked to it. Overnight, with no warning, and no possible way to be protected, the shareholders of Biogen lost billions of dollars. The stock lost over 35% overnight and no one could do a thing about it.
Now let’s look at an even more calamitous event. On September 11, 2001, two planes flew into the World Trade Center. More than 2000 people died from this event. The stock market closed for days because of this. When it re-opened, the SPY’s (S&P Depository Receipts) opened about 8% lower. In spite of the fact that 9/11 was far more catastrophic than the Biogen event, investors and traders who were long SPY’s lost far less than those investors and traders who were long Biogen.
If you find these TradingMarkets Rules worthwhile, then take the next step and learn more information about our Swing Trading College. The Swing Trading College is one of the most popular courses we have offered and a variety of traders – from real-world professional money managers to end-of-day part-timers – have taken advantage of our 14-week course to give their short term trading the extra tools – or major overhaul – they need in order to profit in volatile markets. To learn about the Swing Trading College in greater detail, Click Here.
To read our series “TradingMarkets 10 Trading Rules”, click here for Rule #1, Rule #2, Rule #3, Rule #4 and Rule #5.
You can also read the next installment in our series: Rule #7 – If You Buy Stocks, Buy Established Companies, by clicking here.
David Penn is Editor in Chief at TradingMarkets.com.