Allowing day trading losses to eat up your gains?What's the most common mistake newbie traders make? Allowing day trading losses to eat up all of their gains. No one likes to loose a game. But, losses happen. I don't care how good your strategy and your discipline, you are going to make some bad trades. The trick is knowing what you're going to do about it.
I've talked about having a sound day trading strategy under the strategy section. As I've mentioned, a good trading strategy gives you criteria for exiting the trade. Entering the trade is one thing. But you need to know what to do when that trade goes against you. Some traders draw a line in the sand and say "I will not allow my day trading losses to exceed 2% on any one trade." Others say "Never allow your day trading losses for one day to exceed 5% of the total equity in your account." Both of those ideas are good guidelines, especially for the newbie trader. Here's the basic idea. You never want to loose so much that you cannot play the game tomorrow. The problem is that some newbie traders (and experienced traders too) are a little bit mule-headed. We'll be nice and call it stubborn. So, when a trade goes against them, they refuse to sell. They let the trade go down the pipe, and their equity gets flushed out with it. Then what happens? They hold a little longer because they just know it cannot keep going down - except that it usually does. So, instead of having a plan for preventing major day trading losses, the newbie trader does nothing and just lets the losses mount up. No one likes to loose. And therein lies the problem. When you sell a losing trade, you're admitting you make day trading mistakes. If you make mistakes, then you're not perfect. If you're not perfect, then you beat yourself up for it and you loose confidence as a trader. So, you're better off just denying the day trading losses. Right? Wrong. Day trading mistakes can rise up and bite you in the you-know-what. Let me give you some math that I mention in the section on Keeping Score. Let's say, for example, that you make money on 3 out of 4 of your trades. So, your winning percentage is 75% - that's very good by the way. Next, let's assume that your winners generally make 1.5% gain per trade - not bad either. But your losers average 5% - not good. Well, if you total up the math, then you see that your net loss is actually .5%. So, even though your win vs. loss ratio is pretty good, your day trading losses are eating your lunch. Not good. You can trade for a while that way. But you're just treading water. Eventually, as the preacher said, "If your outgo exceeds your income, then your upkeep is going to be your downfall" - you will have to quit trading because you'll run out of money. So, if you're a newbie trader, or an experienced one, resolve now to decide upon a limit for your losses. These can be mental loss limits or real ones that you program into your trading platform, but resolve now to stop taking these losses. I won't go into detail here, but my students have learned two techniques for limiting their day trading losses. One is called the straddle and the other is averaging down. But, my students know that these are last resort techniques. If they are used on more than 10% of your trades, then your trading is sloppy. Personally, instead of using a set loss limit on my trades, I use technical indicators. And I have certain guidelines in my trading strategy. Here's one that I use when trading gap down stocks. When looking at the 10-minute chart, if the 2 SMA crosses down through the 4 SMA on a long trade, then you get out of that trade, or you straddle the trade. This is my experience. Once a trade goes against you, it will continue to go against you. So, you might want to look at taking your day trading losses and converting them into winners by trading the same stock in the opposite direction.
One of the webinars I did in 2008 included a reference to The Two Twelve Ways to Lose Money in the Stock Market. You might want to print the page and hang it by your computer. If you didn't catch the YouTube version, there's a link to it on the "About Bob..." page. But here's the link for the "Top 12" list:
The Top Twelve Ways to Lose Money in the Stock Market.
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