Learn how to control daily risk while day trading, so that a single losing day is easily recouped by a winning day and won’t ruin your whole week or month.
In addition to controlling risk on individual trades, nearly every professional day trader I know, including myself, also uses a daily stop loss. Just as a day trader shouldn’t let one single trade ruin their day (although this does occasionally happen), professionals also don’t want one single day to ruin their week or month.
Trading for a living is a tough business, and taking a huge single-day loss takes a toll psychologically as well as financially. Day traders rely on their trading capital to live, so taking a huge one-day hit may put that income in jeopardy, or at least make the trader feel that way. Aside from the financial hit, a big loss may shake our confidence, messing with our ability to perform.
Manage your risk on each trade, but even more importantly manage your risk each day so one day’s loss doesn’t kill your income or your confidence. Here’s how to do it.
Managing Trade Risk
Manage trade risk and position size! As a general rule, I encourage all traders to never risk more than 1% on a single trade. If you have a $10,000 account, that means you set a stop loss on your positions so you don’t lose more than $100 on a single trade.
The idea behind this guideline is that with several (or many) trades placed each day, even a string of losing trades won’t significantly draw down your account capital. On the other hand, if risking 10% per trade, as many novices do, then the account can be cut in half (or worse) by several losing trades in a row.
This method of risk control may vary slightly depending on the winning percentage of your strategies though. If you have a very high win rate, you may be willing to risk slightly more on each trade, since a higher win rate is less likely to produce a long string of losses (without some offsetting gains).
Therefore, managing risk on individual trades is very important, but it is equally important for day traders to set a daily stop loss.
Why Use a Daily Stop Loss
When trading any market I ascribe to the 1% rule listed above (usually I risk much less, simply because even risking 1% with a larger account can create positions that are too large for day trading); I don’t risk more than 1% of my account on a single trade. With leverage and the number of trades I can make each day there is no reason to risk more than that since even with keeping risk low, great returns are possible. If you are just starting out with real capital, risk only 0.5% on each trade until you prove your skill in the live market.
The main function of the daily stop loss is to prevent a single day from hurting the overall monthly income. Say your average winning day is $200/day, but when you have a losing day you lose $600 or $700. Under these conditions, even if you win about 80% of trading days (16 out of 20 days a month) you are just barely breaking even.
If you applied a daily stop loss on yourself you could greatly reduce the amount you lose on losing days, which in turn creates a consistent monthly day trading income in the scenario above.
Use a Finviz Elite subscription to see what is moving aggressively in the pre-market and during the day, look for stocks that are gapping pre-market, and run technical filters for stocks breaking out of ranges or other chart patterns.
Incorporating a Daily Stop Loss
Since I risk less than 1% per trade, if I lose 3% in a single day that means I have lost 3 trades in a row, or my losses are greatly outnumbering my winners. In either case, if I lose 3% of my account I am done for the day–that is my personal day trading daily stop loss. If risking 0.5% per trade, set a daily stop loss limit at 2% or 3% as well. This gives more leeway, in that 4 to 6 losing trades can occur in a row before being stopped out.
Since I know how my strategies perform, it is very rare that I lose 3 trades in a row without a winner in there. And winning trades are bigger than losing trades. If 3 losers occur in a row I may not be in the right mind frame or my strategy may not work under those particular conditions. In either case, the consecutive losses let me know I shouldn’t be trading. Losing trades and losing days happen, and that is fine. A daily stop loss contains the damage.
Another type of daily stop loss is based off of the average winning day. If you add up just the winning days each month and then take an average [divide the total sum of profit (in dollars) on winning days by the number of winning days in that month], your daily stop loss should be pretty close to that number. Say your average winning day is $2500, then you shouldn’t be willing to lose much more than $2500 on a losing day. Using this method means your daily stop loss will change with your performance over time.
With this method, a losing day doesn’t wipe out more than one average winning day, and it only takes one average winning day to recover the loss. Stop trading when you have lost more in a single day than you usually make on a winning one.
While occasionally you may be able to recover the loss if you keep trading, more often than not you are not in the right mind frame and will end up losing even more.
Hitting your daily stop loss should be rare, only occurring up to about three times a month, and ideally once a month or less. If you continually lose three trades in a row each day, your strategies or implementation need more work. If you do have winning trades during the day, but you are still hitting your daily stop, then your trades may have some risk/reward issues.
Don’t let one trade ruin your day, and don’t let one day ruin your month.
Using a Daily Stop Loss for Trading – Final Word
These are ideas on how to implement a daily stop loss and how to manage risk. Plot your own method for controlling trade-risk and daily-risk based on your own personal style, strategies, and capital.
In my opinion, the daily stop loss is a huge factor in determining how long a trader stays in the game. If you want to make an income from day trading you need to make more from your winning days than you lose on your losing days. One way to do that is with a daily stop loss.
You may choose a daily loss limit based on the amount of your average winning day. Using such an approach means your daily stop loss may change over time depending on performance. You may also choose to stop trading if you lose 3 (or some other number) trades in a row, or if you lose a certain percentage of your account.
If you are consistently hitting your daily stop loss, it indicates your strategies or implementation need work (see 5 Step Plan for Forex Trading Success). If you aren’t profitable, and therefore can’t create a daily stop loss using the “average profitable day” method, then don’t lose more than 3% of your capital per day.
If these approaches don’t curb the drop in your account value, stop trading with real money, go back to the simulator (demo account), and hone your skill further.
For a downloadable guide on forex trading with loads of forex strategies, see my eBook: The Forex Strategies Guide for Day and Swing Traders 2.0
By Cory Mitchell, CMT