If, to find an effective way to make some additional income, you might consider trying your hand at online trading. If you get it right, the returns can be very attractive and it can fit nicely around your existing work and family commitments. There are many different types of trading to choose from, but whichever option you pick, you can be sure it’s fraught with risk.
Investment risk comes in a range of different forms. There’s the risk that you could interpret the available information incorrectly when making your investment decisions. There are also unpredictable market events that can cause havoc with the markets and do untold damage to your carefully constructed investment portfolio.
In this article, we’re going to take a closer look at three of the main hazards would-be investors need to be aware of before they start making their moves in the markets.
3 Investment Risks to Consider
Throughout history, there have been numerous economic bubbles and manias that have wreaked havoc with the financial markets. While some have been short-lived, isolated events that only affected a small part of the market, others have been full-blown financial crises that have had a much more destructive impact.
1. Flash crashes
While volatility is ever-present in every publicly-traded products, it will usually move within a predictable range – but very occasionally there can be a sudden fall known as a flash crash. A flash crash is an extremely quick decline in the price of a publicly-traded asset that can last for minutes or even seconds, typically followed by a rebound in price. Although short-lived, flash crashes can wipe billions of pounds off the markets.
One of the most well-known examples is the now infamous S&P 500 E-mini futures flash crash in 2010. The crash, which saw S&P E-mini futures collapse by 6% in just seven minutes, was the result of market manipulation by a London trader called Navinder Singh Sarao. He placed a large number of sell orders before cancelling them, spoofing the market and causing the collapse.
One of the unique characteristics of flash crashes is that they occur in nearly every market, including shares, currencies, futures and cryptocurrencies, so you must be aware of them.
2. Financial crises
A financial crisis is a depression of asset prices over a longer period than a flash crash, causing much greater damage to the economy. As the prices of assets fall, traders sell off their investments and people withdraw money from savings accounts due to the fear that their assets are no longer safe in a financial institution. As a result, banks suffer a lack of liquidity and call in their loans, only to find businesses and consumers are unable to pay their debts. That can push the economy into recession or even deep depression.
Several contributing factors can cause a financial crisis. Banking panics, the overvaluation of assets, incentives to take too much risk and regulatory failures have all led to financial crises. Those crises can spread throughout the economy and, like the financial crisis of 2008, affect countries around the world.
3. Financial bubbles
A financial bubble is a period of volatility in a specific asset that’s characterised by the rapid escalation of the price, followed by a price fall. Bubbles are created by a surge in the price of an asset that goes far above its intrinsic value, driven by exuberant market behaviour. Investors are then no longer willing to buy at the inflated price, and a mass sell-off occurs, causing the bubble to burst.
There have been several memorable financial bubbles in recent years. During the late 1990s and early 2000s, the dot-com boom took place, which saw investors buy shares in tech companies at vastly overinflated prices. When investors realised they could not sell the shares at a higher price, confidence was lost and there was a market correction that saw share values fall dramatically.
Try before you buy
If you think online trading could be an effective way to increase your income this year, you’d be wise to first use one of the many free trading simulators out there that allow you to invest virtual cash before you risk your own. With financial bubbles, flash crashes and crises to look out for, it’s not surprising that more people lose money than make money online when trading. Taking this approach will allow you to perfect your trading strategy before putting your money at risk. Good luck and happy trading!