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Day Trading Risk Management
from: Dan Alvarez"Day Trading Risk Management Not risking too much money on any
given trade is essential to succeeding as a day trader.
Unfortunately, when most people start day trading, they do not
think about the risk that they are taking - only about the
potential rewards. Every day trading strategy must take into
consideration the maximum percentage of the total trading
capital that should be risked in any one transaction. In fact, a
day trader's ability to limit his losses is just as important
(or even more important) as his success in managing winning
trades. Think about it. If a trader losses a small amount on
every transaction, won't he stay in the game a lot longer?
Taking huge losses is one of the primary reasons why so many
traders don't survive in this business. Why do traders commit
financial suicide this way, you may ask? If all big losses start
small, shouldn't it be easy to prevent a small loss from
becoming unmanageable? The answer is ""YES.""
Limiting losses when day trading involves a lot of common sense.
To begin with, no trader should risk more than 2 to 5% of his
trading capital on any given trade. Why? If a trader sticks to a
1% to 2% maximum loss rule, his chances of succeeding are
greatly increased because it will take many consecutive losses
to wipe him out and he will have more opportunities to make
winning trades. If a trader would be trading a $10,000 account,
he should not lose more than $100 to $200 (1% to 2%) on every
position taken. Using the same reasoning, if we are dealing with
a trading account that's $100,000 in size, the maximum allowable
losses can be increased to $1,000 or $2,000 per trade. Based on
these percentages and on the amount the price can move against
the trader (determined from the charts), he can calculate the
maximum size his position should have. This becomes much clearer
with an example:
Position Sizing Example using Currencies (to learn more about
currencies read this section) (NEW: day trading robot)
Assume that an investor can trade a lot of 100,000 USD with a
2,000 USD deposit (50 to 1 leverage) and that he has $10,000 in
an account. With this account size, he can trade a maximum of 5
lots (5 x 2000 margin deposit = 10,000), but is this a wise
thing to do? Let's look into this a little further. Let's say
that based on his trading strategy, the day trader analyzes the
chart and determines that in order for him to take a long
position with a potential reward of $800 per lot, he must be
willing to lose $200 per lot. He realizes that if he takes a
5-lot position and all goes well, he could have a gain of $4000
or 40% (5 lots x $800 per lot = $4,000). Using a position size
of 5 lots would also require that he be willing to lose $1,000
(5 lots x $200 per lot = $1,000). Should he take the trade? Not
with 5 lots!!! A loss of $1,000 represents 10% of his trading
capital!!! How long will anyone be in business after a few
consecutive 10% loses? In this example, his maximum position
size should only be one lot. With one lot, he would be risking
$200 (2% of his account size) to make $800 (8% return). While it
might be tempting to try to make the $4,000 in one trade, it is
not a smart thing to do so. Trading is all about your
probability of survival. To survive, you cannot risk more than
you should. Risking too much is not smart money management.
*In general, day traders with less than $10,000 should consider
trading with a mini account. A forex mini account can be opened
with as little as a few hundred bucks.
Position Sizing Example using Stocks (remember that to day trade
stocks you need at least $25,000 in your account by law, so I
will use an account size of $30,000 in the example below)
Assume that an investor has a $30,000 account to day trade
stocks. He wants to trade Intel (INTC) stock, which is at $30 a
share. Based on his strategy, he determines that the stock can
appreciate $1.00 during the day, but to take advantage of the
appreciation, he must risk $0.50. Since he has an intraday
margin of 25% (4 to 1 leverage) he can take a $120,000 maximum
position in INTC with his $30,000 (4 x 30,000 = 120,000). Should
he do it? Let's do the numbers. With $120,000, the trader can
buy 4,000 shares of INTC (120,000 / 30 = 4,000). If INTC moves
up 1 point, the trader gains $4,000. If it drops $0.50 (his stop
loss), he loses 2,000. A two thousand dollar loss represents
6.7% of his trading capital - much too big a risk for him to
take. Consequently, a 4000-share INTC position is too large for
his account size. Based on a 1% ($300) maximum loss, the day
trader should not buy more than 600 Intel shares (300 / 0.50 =
600). Based on a 2% ($600) risk, the maximum trade size becomes
1200 shares.
Risk in day trading (or in any other form of speculation) must
be controlled. One effective way of managing risk in trading is
by not taking on a position larger than an account of a given
size could handle. While some authors and ""experts"" have
complicated ways of determining position size, these methods
tend to confuse traders and slow them down. The 1 to 2% rule
will keep traders out of trouble and it is simple to apply. It
is common sense more than anything else. Don't become another
day trading statistic - limit your losses all the time with
protective stop orders!!! Read more about stop orders in the day
trading basics section.
Read about the importance of using a specific strategy in
trading.
"
About the author:
Author is an established writer and arbitrage trader. Author
makes it easy for any one wishing to start in trading.
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