Failing at Day Trading?

Failing at day trading is a real possibility. It is easy to look in from the outside, hear great tales of wealth, and think that failure is impossible. After all, who attempts something with the goal in mind of failing at it? But, failing at day trading is a real possibility. In fact, it is not that difficult to achieve.

The statistics for "newbies" making it past their first year in trading are not good. Losing money seems almost inevitable in the beginning. That is why I have written quite a bit on this web site about how to succeed in trading - how to get educated, develop a strategy, and start with pretend money before you start using real money.

To fail at day trading, you must do one of two things really well. You must either have more losing trades than you do winning trades, or you must lose more on your losing trades than you win on your winning trades. So, the simple prescription for solving this problem is to figure out how to have fewer and smaller losing trades. After all, it isn't the winning trades that are causing the failure - it's the losing ones.

It would be nice if every trade came neatly wrapped with a ribbon on top. Inside would be a guaranteed daily return of 3 to 5%, complete with easy to understand charts, obvious entry and exit points, and zero losers.

It would be nice. But it's not going to happen. If you're a new trader or you're just starting to study charts and the technical indicators, then I know it looks obvious enough. Buying low and selling high, you'll be millionaire in 2.3 months!

The cold truth is that you will have losses. Every trade will not be a winning trade. Failing at day trading is a real possibility. And what you do with your losing trades will be more determinate of your success than your winning trades. That's right. Your losing trades will be more determinate of your success than your winning trades.

Now, why do I say that? Because, one of the major shortcomings of all traders is that we hold onto our losing trades far too long and these losses (even with a win:loss ratio of 3:1) will eat up all of the gains we've achieved if we do not put a limit on those losses.

If this doesn't apply to you, then congratulations. You are either a disciplined trader or you have a low tolerance for risk - or both. But, the heavy losses are incurred by those with a high tolerance of risk and a lack of discipline when it comes to cutting your losses.

The purpose of this page is to explain "how to exit a bad trade". If you feel the cold slap of reality a few times, then take note. If you feel that I am speaking directly to you, then understand it is a common problem. The good news is this: you can change your behavior. While I cannot prescribe a way for you to get back all of the money you've lost, I can tell you ways to help stop the bleeding and keep from losing much more. My goal is to keep you out of those statistics that state that failing at day trading is more likely than success.

So, let's begin.

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First, I'll begin by asking you a question. And please answer the question before you continue reading. Here it is: "When is the best time to sell a losing trade?" Your answer: _________ .

If you do not have a ready answer to this question then you now know why you keep losing money. You lack a trading strategy that tells you exactly when to sell a losing trade. I've talked about having a trading strategy on other pages. But part of that strategy must include what to do with a stock when the price goes against you. There are decisions to be made. And if you don't know the answer to the question I just asked, then you'll flounder around and get all wishy-washy at a critical time in the trade.

Now, I'm not going to give you an exact exit strategy and claim that failing at day trading is impossible if you follow this strategy. Not to be elusive, but it depends upon your tolerance for risk, the time frame you are trading, etc. But here are some possible answers to the question, "When is the best time to sell a losing trade?"

a) as soon as you realize it's a losing trade;

b) as soon as the price tells you that your interpretation of the chart was incorrect;

c) as soon as the price goes below your purchase price by _____ % (2,3,5?);

d) as soon as you lose 5% of your total portfolio on this single trade;

e) after you've held the stock for _____ days (2,3,5?)without a profit;

f) as soon as the price hits a new intraday low;

g) when the 2 SMA line breaks through the 6 SMA line on the 15-minute chart;

h) never.

As you can see, there are many approaches to answering the question. The truth is that it doesn't matter which answer you choose - as long as you are comfortable with the answer, you consistently follow your strategy, and the strategy helps you become a more profitable trader.

The thing about a strategy is this: it gives you an objective way to determine your trading stops, so that reason and strategy provide the triggers for selling, not your emotions.

Many of the strategies I just listed can be programed right into your trade. You can establish stop losses or trailing stops as soon as you place your trade. And, especially for the new trader, this is a wise suggestion. Establishing a stop loss on your trade will keep you from talking yourself out of your own strategy.

The other purpose of having an exit strategy is this: it gives you an objective way to measure the success or failure of that strategy. A strategy is only as good as the profit it creates. For example, you could have an exit strategy that sells a stock every time it falls 1% below your purchase price. While this would succeed in keeping your losses tight, it would fail because prices often fluctuate this much within a single 5-minute candle and you would be stopped out much too quickly.

So, you can establish an exit strategy and then test it to determine its success. But the time to change straegies is not in the middle of a trade. Trade your strategy. Evaluate its success. Then change your strategy as you gain more experience. I advise that you write this exit strategy on a piece of paper and hang it over your computer. You've heard the mantra "Plan your trade and trade your plan".

What I want to cover next is another problem, related to the topic of exiting the trade. Let's say you are currently holding a losing trade. You now understand the need for an exit strategy and you've successfully raised your foot and kicked yourself in the rear more than once, vowing "I'll never hold another losing trade again". But, for now, you're still holding this losing trade and now you're frozen. You don't want to sell now, at this price, because you've riden it down this far. But, several fact are true.

1) you don't know how much lower it will go;

2) even if the price doesn't go any lower, you're losing money because your capital is tied up with a losing trade and your capital is treading water;

3) you're probably losing patience and you're tempted to just dump the whole thing at the next lowest price and put the trade behind you.

So, the question becomes: "Is there anything you can do to mitigate your losses?" The answer is "yes". You need a plan for how to get through this mess and the plan I'll suggest will get you moving in the right direction.

[to be cont.]