Trend reversals

We said earlier in this section that analyzing risk should be a priority before even thinking about calling your broker or clicking that buy button for the stock you are interested in. Risk assessment is an important tool on your strategy box when trading stocks. We already know that lower priced stocks can generate hefty returns once it starts moving your direction, since we can buy more shares compared with stocks trading at a much higher per share value. It looks like its easier to beat the market with these type of stocks, on a bull market of course. A return of over 100% is impressive, but how does a 100% loss sound like to you? when you think about the upside and the stock is moving on your direction you ignore risk since you are so confident that it will keep going that way, at this kind of situation, quality is also ignored, who would settle for a lower return if there are better options that that generates a lot more? We'll take a look at our two accounts and see if they can both weather a correction, instead of a +5.00 movement on our two stocks, well see how a -5.00 movement downward would affect our funds.

That once sexy, high octane account A, couldn't handle its high powered energy stores after all. Instead of shooting up from the launch pad, there are some unnoticed failure in the system unable to lift itself upwards and resorted to self destruction, literally obliterating itself into ashes (or peanuts). Well sounds like it, just look at the results. Account B's funds was able to survive a correction of 5 points downward and just shed off 12.5% its value. Account A on the other hand is ruined, not even capable of taking a beating of negative 5 points because of where the price is at which is $4.00. Account A turned a $20,000 investment down to $500, scary isn't it? actually this is a nightmare. Comparing the two, account B's $600 fund even beat Account A's $20,000 fund by $25 US dollars. When buying lower priced stocks, the impact on your principal is phenomenal whether on the upside or the downside. Knowing how to look at risks before your target gains should save you from losing a significant portion of your investment money. On the other hand, buying a more expensive stock gives you a lower rate of return per unit of movement. However, it generates a lower loss percentage which sounds better on a jittery market condition.

Some stocks are supported at a price level preventing it from plunging all the way down like what we did on Archer broadcast company (ABC). It is a means of showing you how a certain amount of investment money would perform at a certain stock price and the quantity of shares traded at a given volatility. Earlier in this topic we covered that stock prices fluctuate based on the current supply and demand for it, which are all controlled by investors emotions or market sentiment. When nobody wants to buy a stock because of its bad fundamentals, that will cause the price to decrease in value because everybody is trying to get rid of it and nobody wants to own it. Therefore, the price couldn't be supported because there aren't enough buyers to keep the price from falling further. Owning a stock that suddenly drops in value for no particular reason rarely happens, if its a good company and everybody holds on to its stocks nothing major should happen. Except if a person or a fund manager holding a significant quantity of that company's shares suddenly unloads all his holdings or selling it for no reason or just simply to take profits, then there would be a drop in price. When there are enough buyers for that unloaded quantity of shares, the stock price will be supported as long as the company's fundamentals remain exceptional.

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