On Thursday 18th of November 2015, for the second time last year, there was an extreme upward movement on one of listed companies on US Stock Markets. As usually, many people began to think out loud “How much it was possible to earn?”. I will answer the opposite question: How much it was possible to lose. I published this article right after that, but on my polish website. Today translation here, so you will be aware of this kind of situation might happen.
In USA trading on declines on companies listed on NYSE, NASDAQ and AMEX is very popular. This increases trading possibilities, but also provides additional risk to which trader is exposes if won’t expect extreme occurrences.
KBIO Company (similarly to AQXP a few months ago) recorded an increase of 1000% within only a few hours. How much it was possible to lose on it?
When you have an open long position on shares, you know what your risk is. It is limited to a decrease in the company’s rate of 100%. Opening the position with a value of e.g. 1000$ you may maximally lose 1000$. In case of opening short position, i.e. trading on declines – opening the position with a value of 1000$, it is possible to say that your risk is generally unlimited.
Risk of trading on declines
Below I present the graph of KBIO Company, at first please look at it:
Look at the move from 2$ to 19.00$, which was held in post-session hours – from 10:00pm to 1am of Polish time. Imagine you are in a short position from the prices of e.g. 2.00$ with the size of 1000 shares.
If at 10:00pm you calmly closed it and went to bed or for a party, not having any secure orders, the next day your account will definitely decrease or your position was closed by the broker with the call for surcharge.
The loss at 1000 shares in the worst moment was in post market 17k$. Even worse you may feel of next day in premarket when the price reached 24$, and your loss could increase to 22k$. What if we take into account the size of equitable position?
You will ask “And why I would short it from the price of 2$?”. Look at what the company did within a few earlier days:
An increase of 40 cents to 2.5$ was already a quite respectable movement. Traders tend to think “It won’t increase more” (or by analogy “it won’t decrease more, it must turn”). As you see, such examples show how solid lesson you can get when you don’t apply at least a minimal security.
The entire movement occurred due to quite important news, which appeared on the company right after the session. It caused rarely met short squeeze, which is very dangerous on companies with small liquidity, particularly in pre or post-session trading.
Why I write about it?
Media publicized the situation of Joe Cambell, persons who opened the short position on the KBIO Company in hope of drop. Joe unaware of what happened on the company as they say “caught on too late” when the broker required extra charge of 108k$ to the account.
Joe had a bad luck, I admit. Such situations are rare. Let us also note that on the account he had 37k$. So it wasn’t the smallest account. However, quite strange as to this situation the broker behaved, because usually they close at shorts position, when the loss constitutes a specific level % of the amount (particularly at short positions where up to cover 2.5$ times large sum is required). In this case, however, I think that it could result from small liquidity.
The story you can read here: Joe Cambell’s story.
As you can see, when your account exceeds 25k$, which provides a minimum level of capital in accordance with the Pattern Day Trader regulation, the risk is huge in extreme situations. Unfortunately, it was this time, probably this regards f much greater number of traders.
Last year, many traders were caught on GTAT Company. There persons with long have experienced a strong shock. It would seem that the company deals quite decently – as a matter of fact it was traded at the price of about 11$. Suddenly its quotations were suspended, the company transferred to Pink Sheets (i.e. as a junk company) and its quotes were on a level of 1$.
Similar situation happened to me a few years ago. The company, which as a part of daytrading I traded in quick upward movement, suddenly was suspended. After a few weeks or months (I don’t already remember), its quotes were open at about 80%. It hurt, but I had small size, so there was no tragedy. Such cases from the time to time may happen.
Be sure of own strategy when you trade on declines
Repeatedly on the website I wrote already that I often traded on shorts, particularly on so-called pump and dumps. However, it is important to stick to a clear strategy, rather than guess. It is also necessary to appropriate r manage the risk.
Thanks to that you reduce your risk. Another important thing: remember about it, peculiarly on pharmaceutical companies (such as KBIO), that news in relation to FDA decision, or taking over the company may affect its rate (both growth and declines). And it involves large gaps at the opening/closing.
Always keep an appropriate capital in the trading account – and trade with sizes adapted to your financial securities.
