Become a successful day trader: Understanding Risk-Reward

RagingBullRagingBull ·

If you want to become a successful day trader, then you’ll need to understand a few key pillars. There are various styles of trading, such as trading biotech stocks, penny stocks, and even options. If you want to get an inside look of someone who makes money trading penny stocks, check it out here. Getting back. Those who want to be a day trader need to first understand there are various rules to be allowed to day trade. In short, you’re going to need to maintain an account with at least $25K in it and make sure it stays over that amount. This is due to SEC and FINRA regulations. If you’re considered a day trader and looking for resources, here are 5 free resources to help you along the way. Even though there are different styles of trading, nearly all successful day traders understand risk versus reward. You see, you shouldn’t risk more than your potential reward. If you risk more than you can make, you could become a failed day trader. That said, let’s take a look at the importance of risk-reward.

Become a successful day trader: Understanding risk-reward

Ever heard the term never risk more than you can make? Well, it’s a good rule in both gambling and trading. If you’ve ever heard of the blackjack players who “took down” the casinos, well they used risk-reward for their bets. You see, even though they were counting cards, they would only risk a certain amount until the deck was “hot”, then they would risk more. They knew the potential reward when the deck was “hot” was greater than when it was “cold”. In other words, if they had an edge, they would bet more. If you want to get an inside look on how someone is able to minimize their risk and maximize their reward, take a look here.

Now, let’s take a look at risk-reward and how you could use it in your everyday trading.

In general, you never want to risk $1 to make $1. When your risk-reward ratio is 1-1, your win percentage would need to be at least 51% for you to be gross profitable, but most likely you would be down due to commissions and fees. This is what you want to avoid when you want to become a successful day trader. That said, you want to risk $1 to make at least $2. That means if you’re willing to risk $500 per trade, you need to make at least $1,000 on those trades. That way, even if you’re right 60% of the time, you would still be profitable. For example, let’s assume you used this risk-reward ratio. If you have 100 trades and are right 60% of the time and take profits when you’re up $1,000 and cut your losses at $500…you could still be up $40K ($1,000 * 0.60 – $500 * 0.40). It sounds simple, but you’ll need to remain disciplined.

That in mind, let’s take a look at how some of the pros incorporate risk-reward into their trading.

Become a successful day trader: How the pros use risk-reward

If you want to be a successful day trader, or just a trader, you should write out a trading plan and incorporate risk-reward. The pros do this all the time. Here’s a look at one of Kyle Dennis’ trading plans.

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Buy Zone: $1.80 to $2.00

Profit Zone: $2.50 or higher

Stop Zone: $1.70 or below

day trader

Let’s say Kyle buys this stock right around $1.95 and stops out if the stock gets to $1.70. He’s looking to take profits above $2.50. That said, his risk-reward ratio is slightly greater than 1-2. He’s risking a quarter to make 55 cents per share.

Similarly, Jeff Bishop does the same with his trading. Even though he primarily trades options, he’ll also dabble in trading ETFs, day trading and swing trading some times. With his strategy, he’s always looking to at least double his money. When you get the risk-reward ratio down to a T, you could have trades like this.

day trader

The Bottom Line

If you want to be a day trader, one of the most important factors to understand is risk-reward. If you don’t know how to properly risk on your trades…it doesn’t matter how good your strategy is. In general, you want to have a risk-reward ratio of at least 1-2. In other words, you want to risk 1 unit in order to make at least 2 units. This should help you with your disicipline, as well as minimize any detrimental losses when you’re looking to become a day trader.

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