Day trading losses can be minimized. That’s the first thing you need to realize as a new day trader. While you cannot prevent losing money completely, there are many things you can do so you don't completely lose your money. There's a difference! This article discusses some of the many things you can do to limit your losses.
I know how frustrating it can be to lose money in the market. You are trying to do your best and it seems the market is just out to get you sometimes. For example, you'll set a stop (because everyone knows you should set a stop), only to see price hit your stop and then finally go in the direction you expected. That alone is enough to make you want to stop placing stops. And then, of course, if you stop placing stops then you'll be holding a trade where you didn't place a stop and you're kicking yourself because price moved through your stop and created huge losses for you.
In this article, I’m going to talk about using stop losses for setting limits to your day trading losses. While this alone won’t be enough to fix the problem, it will definitely help you survive a little longer.
Most traders have heard of stop losses. But there are various types of stop losses and many ways to use them in your trading to limit your day trading losses. Let’s talk about a few of them.
Raise your hand if you've ever had a losing trade, a losing day, or a losing week. Congratulations! You're in good company. All of the best traders have been in that situation. And, as frustrating as it is, know that you can move through this. You can get better. You can continue to learn. You can continue to improve.
If necessary, go back to paper trading or at least use less equity than you are accustomed to using. This will mitigate both the fear and the losses until you build your confidence back up again.
A key part of learning how to limit your losses is learning how to identify areas of Support & Resistance on the price chart. Knowing these areas becomes "the basis for your trade" and thereby the reason for your stop. To learn more about Support & Resistance on the price charts, then watch this free video series.
A stop loss is a mechanism available from your broker. In simple terms, it states “I am going long on XYZ Stock. If price falls to this point (a set price or a percentage of the original price), then I authorize my broker to exit the trade at that point.
By setting up an automatic stop loss, you are doing several things that are important.
(1) You are acknowledging the fact that the trade could go against you. The acceptance of this fact is not to be taken lightly because it shows that the trader is based in reality and not in some “pie-in-the-sky” belief that every trade will go in his/her favor. So this is important.
(2) You are stating “this is the maximum amount I am willing to lose on this trade”. You are drawing a line in the sand and saying you will not cross it. This line should be something where you won’t feel nauseated if price actually falls that low. It’s a loss and a risk you are willing to take to play the game. There is another aspect of this called the risk:reward ratio that I won’t address here.
(3) You are accepting the fact that you are not a disciplined trader. This is tough to accept for many traders, but day trading losses are amplified by traders who won’t accept their humanity and their limitations. You see, the human mind has a powerful ability to rationalize our behavior. If we get into a trade that goes against us, then all sorts of rationalizing begins to kick in because we hate to be wrong, we’re stubborn, and we can always find one bit of technical analysis that will justify our behavior.
It's important to study your broker's rules and understand the various types of stop losses available on your account. But let’s take a look at a few of the larger issues here because they are an important part of limiting your day trading losses.
1. Physical or hard stop loss. This is when you set the stop loss with your broker. It’s a real, physical stop in place that will be executed on your behalf by your broker. This can be set to expire at the end of the day or it can be set as GTC (“good until cancelled”).
2. Mental stop. This is when you tell yourself “if price goes to this point then I’ll exit the trade”. Obviously, there are a few weaknesses with this system, the primary one being the rationalization effect already mentioned. But, more experienced traders who use a strict technical set-up for their trades can use the reverse of that set-up to limit their day trading losses.
3. Flash crash stop. This is a sort of hybrid of the first two stops. In this one, you set a physical stop that is lower than your mental stop just in case you lose your internet connection or the market has a flash crash. You are protected from catastrophe, but you still use the technical aspects of the trade to make you exit.
4. Moveable stop. This is a phrase I use to describe the following situation. You enter a trade and set a physical stop. As the trade progresses, you move the stop closer to price. If the trade makes a profit, then you move the stop higher to reduce the risk and lock in profit. If the trade goes against you, then you move the stop higher to reduce the risk. This is a manually adjusted physical stop and I prefer it to the next stop idea.
5. Trailing stop. In a trailing stop, you use either a set dollar amount or a set percentage amount and you tell the broker “if price falls this much below its last highest price, then exit the trade”. So, if you are using a 1% trailing stop of AMZN and the last highest price was $225.00, then you would automatically exit the trade when price fell to $222.75 (1% below its last highest price). While this technique works for some traders and “keeps them in the green”, it also means that you are allowing price to move against you before you exit the trade. Personally, I’m not a big fan of the trailing stop for this reason, but it has its uses. One of those uses is when you use a trailing stop on half of their position and use a manual stop on the other half.
While this discussion of day trading losses has not been exhaustive, my hope is that it has triggered some ideas for you that might help you increase your profits.
Here's a YouTube Video about trading losses.
After you watch the video listed above, you can click here to read another article about Day Trading Losses.