I’m willing to bet all my Apple-manufactured possessions (including my future iPad2) that at least once in your trading career, you’ve felt the need to take more trades even though you’ve already incurred more than your usual daily losses. In such instances, you often think to yourself that with more trades you will be able to offset your losses for the day.
But what if they end up being losers? Then my friend, you set yourself up for more pain and dug yourself a deeper hole to climb out of. Proper risk management crucial if you don’t want to lose your shirt, and it’s particularly important for day traders who take many trades per day because there’s a bigger chance of going on consecutive losing streaks.
There will be times that you will get so caught up in the motions of the market that you lose sight of your primary goal: to protect your capital. And this is precisely why you need to set a daily loss limit. It tells you that you’ve had enough, and that it’s time to pack it up and just call it a day.
It doesn’t necessarily mean that you are a lousy trader; there are just days when your game is off, or maybe your trading system was not designed for that day’s market environment. Just like professional athletes who sometimes underperform, traders also experience those days when they feel out of sync with the markets.
Even the great tennis player, Roger Federer (who has won 16 Grand Slam singles titles), has had his share of bad days. And it’s just too bad for you Federer Express fans that he was up against Novak Djokovic during the Australian Open semi-finals on one of those off days.
Setting a maximum trading loss per day isn’t hard. You just have to take note that it has to depend on your trading personality and risk tolerance. Here are some personal suggestions:
- Limit your losses to a fraction of your profit target for each day. If, for instance, you aim for a 1.5% gain each day, you can set your maximum trading loss to half of that, or .75%.
- If you have experience and kept a well-detailed record of your trading history (i.e. a trading journal) then you can calculate your average win per day and set your maximum trading loss to half your average gain. Let’s say your average gain per day of all your winning days is equivalent to 0.5%, then you can set your daily maximum trading loss to 0.25%.
- You can also set it to a fraction of a longer term number, like a max 10% loss per month. With 20 trading days a month on average, that’s 0.50% per day.
Try these out or come up with your own, and whether you choose to use one of my suggestions or not, the important thing is that you have one. The fact is all traders will eventually experience a losing day, so you should always have an intraday maximum trading loss level set.
And once you’ve reached this limit–and here’s the hard part–stop trading for the day! Instead of scrambling to come up with more unprepared trade ideas to make up for those losses, you just have to swallow your pride and admit that it’s just one of those days that you have to sit it out.
Ralph Waldo Emerson once said that, “Our greatest glory is not in never failing, but in rising up every time we fail.” So learn to accept defeat every once in a while as we need to remember that trading is a long drawn out war, and not a single battle. By protecting your ego and your account today, you have assured that the losses incurred are small enough to easily overcome tomorrow.