Page 41 - Trading #101 Course – Part One: Trading Basics

TRADING #101 COURSE – PART ONE: TRADING BASICS /2017-10-06

Ultimately, how you handle margin, leverage and debt needs to be a calculated
business decision on your part. You must carefully weigh the pros and cons of using
margin and determine how much margin to use and when to use it. Bottom line is,
beware of the dreaded margin call. It’s all about risk and managing that risk.

My suggestion is that only experienced traders and investors use margin. And, when a
novice trader begins to apply this tool they should do so slowly and carefully. It is
crucial that position size be carefully calculated to prevent yourself from over extending
risk. Refer to Chapter 13 on money management in this course. There are formulas to
help you determine how to size your positions effectively when using margin.

Volatility and Market Gaps

The term volatility refers to dramatic, short-term fluctuations of price in a market or
individual financial instrument. Quick drops or increases in price in a market or financial
instrument can create market gaps.
On a chart, a gap looks like a hyperbolic move to the upside or downside. Volatility and
market gaps can be caused by many factors, including overall market crashes, breaking
news, scheduled Federal Reserve announcements, and such.

Typically, traders love volatility because when the market is volatile, there is movement,
and traders make money when they are correct about which way the market is moving.
When there is no movement or volatility in the market, traders are not able to capitalize
on their ability to pinpoint what direction the market is moving, and they are not given
opportunities to profit from their skills.
If we look at the history of the markets up until this point in time, we can study Tables
6.3, 6.4, and 6.5 to find patterns of volatility in the Dow Jones Industrial Average (DJIA).

Table 6.3 shows a top 10 list of the largest daily changes to the downside in the DJIA.
Here you can find statistics on some of the most significant drops in the U.S. market,
such as the crashes of 1929, 1987, and 2008. During these drops the volatility was
high.
When you look at Table 6.4, which shows the top 10 list of largest daily changes to the
upside in the DJIA, you can see that typically when there is a crash to the downside, as
in 1929, shortly afterward there is usually high volatility to the upside during the period
where the market is in a correction.
In Table 6.3, items ranked 2, 3, and 4 show three days when the DJIA market dropped
12 percent, 11 percent, and 9 percent, respectively, during the period between October
28 and November 6, 1929. Interestingly, though, when you look at Table 6.4 you will

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