Day Trading Money Management
Day trading as a business can be very profitable. It is probably the safest form of investing, as you are focusing on a small number of positions, you are not holding any positions overnight and you are able to enter and exit trades with pinpoint accuracy. However, many day traders find themselves losing due to poor day trading money management.
How Much Should You Risk
The size of your trading position, is in direct proportion to the value of your portfolio. The key to day tradingsuccess is to avoid big losers. I can not tell you how many times early in my trading career, that I would be up huge over a 5-day period, only to have a big loser wipe out 50% of my gains. So, to avoid this bad habit, you should only risk a total of 1% of your portfolio on any one trade. Most traders take this rule of thumb, and just put a 1% stop loss out there and when that is hit, they just take the loss. If you have put on around 1,000 day trades or more, you know all too well that a 1% loss can happen. So, in order to avoid taking constant hits, you should allow yourself to take a 2% hit on your position, where the dollar loss from this trade will only represent 1% of your overall account value. Now that I have confused both of us, let me try to say that a little easier. You simply want the total dollar amount invested per position, to equate to 12.5% of your total marginable equity. So, if your account value is $100,000 you will have $400,000 dollars in margin buying power, and should use $50,000 for each trade. Remember, this $50,000 you use only represents 12.5% of your marginable equity. This way if you take a 2% hit, it will only be 1% of your total account value.
Stops are not meant to be hit
It really upsets me when I hear so called professionals advise new traders to set stop loss amounts. Doesn’t that seem like a general rule? Trading is a game of precision, and does not operate in the realm of gray. Yes, you need a stop loss order for every trade, but it is a fail safe. In this article we have discussed the power of a 2% stop rule and overall day trading money management. But do you think you should let every losing trade hit your stop? Of course not. Now I am not suggesting that we all become rogue traders and trade without stops. The minute you see that the trade is wrong, get out with small hit. Because in the end, the goal here is to see a small number of .25% or .5% losses, while your winners are in the range of 1%-3%. This is how you will win the game. Again, the 2% stop loss is for the unexpected sharp counter move, and it is not your goal to have this stop hit. You should know well before your stop is hit if you are in a bad trade.
Operate in Cash
Day trading is a cash business. The only loan you should be using is with your day trading margin buying power. Do not start or continue to day trade, if you have to take out loans, credit, or use part of your retirement to get in the game. Traders that operate with a positive cash flow and utilize day trading money management rules, have a much higher success rate than traders that start out in the red.