Day trading involves buying a stock and reselling it for a profit the same day. Many people turn to day trading because it’s rewarding when done correctly. However, if you don’t do your research and have the right method, day trading can also lead to some serious losses. Learn the information you need to know to limit losses when day trading.
Take a Look at Your Expected Return
The first step in limiting your losses when day trading is figuring out the expected return on all the trades you’re considering. You can use the following formula to calculate the expected return:
Expected Return = [(Probability of Gain) x (Take Profit % Gain)] + [(Probability of Loss) x (Stop Loss % Loss)]
Once you calculate the expected return on each trade you’re considering, you can compare the results and choose the ones that offer the most opportunity for profit.
Manage Your Risk
Another important way to limit day trading losses is to manage your risk on individual trades. You should never risk more than 1 percent of your balance on one trade. As an example, if you have $50,000 in your trading account, you never want to risk more than $500 on a single trade. By keeping this rule in mind, you know you’ll never lose everything if you happen to have a bad day.
Create a Daily Stopping Point
When you’re coming up with your day trading strategy, decide how much you can afford to risk each day. You have a few ways to determine this stopping point. You can plan to stop if you lose 3 percent of your account, if you have three losing trades in a row, or if you lose the sum of your average daily profits. Keep in mind that if you decide to create a stopping point based on your average profits, the amount you can afford to lose will increase over time as you improve your skills.
Enact Stop-Loss Orders
With a stop-loss order, you can minimize losses by deciding on a specific price that doesn’t go below your tolerance for risk. If the price of your trade reaches the stop-loss number, you know it’s time to exit. Along with the physical stop-loss order you create, you can also come up with a mental stop-loss order. You can put this plan in place to exit a transaction if the trade takes a sudden downward turn.
Use Limit Orders
Along with stop-loss orders, consider using limit orders as part of your day trading strategy. You can use limit orders for buying and selling. A buy limit order will purchase a stock only if it’s below the limit price, and a sell limit order will sell a stock only when it’s at or above the limit price.
Remember that one of the best ways to limit losses when day trading is to create a plan and stick with it. Learn more about putting together this plan to limit day trading losses by exploring the following infographic.