14.8 Caution day trading

Day trading requires long-term commitment and risk management. Ultimately if we are not able to preserve our capital, we will not be able to survive in the game. So how do we start with risk management in day trading? We need to consider even day trading as a business with a proper business plan, strategies and specific targets. Each trader will have to determine the amount of money he or she is willing to risk. For instance, Mr X may be comfortable with one level of risk and Mr Y maybe comfortable with another level of risk. Now, you need to determine the amount of money that you can afford to lose without getting emotionally disturbed and losing your sleep.

For example

Let’s say that you are willing to lose a certain percentage of money which can be called the ‘tilt figure’. Keep this number in mind and once you lose this much money in a single day, stop trading. No trader should risk more than 2 to 5 per cent of his trading capital on any given trade. Why? If a trader sticks to a 1 to 2 per cent maximum loss rule, his or her chances of succeeding are greatly increased because it will take many consecutive losses to wipe him or her out and he or she will have more opportunities to make winning trades.

Another rule which can be followed is that ‘three strikes and you are out’. It means that if you lose three trades in a row, stop trading. Re-evaluate your trading strategies and style and trade only after doing a thorough analysis of what went wrong and how you are going to correct it. Always calculate your ‘risk to reward ratio’ before you enter in a trade. Do not trade if this ratio is more than 1:3. What this means is that you have a chance of winning three trades against losing one with this risk to reward ratio. Anything more than this should be considered as too risky. Never ever trade without using stops. Use of stop loss is a must in each trade. This should be your cardinal principle. At times when you are unable to figure out the mood of the markets or the market seems to be unpredictable, don’t trade. Rest a while.