In day trading, the most important thing is risk management. Surprisingly, many people jump into day trading without giving much thought to risk management. Manage your risk first, rewards will come later.
Day trading requires long term commitment. You have to be persistent. You need to improve continuously. That’s why risk management is important. If you do not preserve your capital, you will not be able to survive long in this game and you will be unable to reap the real profits.
So how do you start with risk management in day trading? Treat day trading as a business. Make a good business plan with proper targets. Risk management should be an important part of this business plan. Now risk management may require a number of different control levels like managing your account balance.Making sure, it does not fall below a certain level. Than you need to learn how to manage losses in each trade. Your business plan should be long term. You should think about yourself as a long term player.
So how do you manage your account balance? Each trader will have to determine the amount of money, he or she is willing to risk. You see, I may be comfortable with one level of risk and you 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. Call this number, “The Tilt Number.” Keep this number in mind and once you lose this much money in a single day, stop trading. Your trading strategies might be flawed. You need to re-evaluate your methodologies before you trade again.
Another rule that you can follow is,” Three Strikes and you are out.” What this means is that if you lose three trades in a row, stop trading. Re-evaluate your trading strategies and style and only trade after 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 the Risk to Reward Ratio is more than 1:3. What this means is that you have a chance of winning 3 trades against losing 1 with this Risk to Reward Ratio. Any thing more than this should be considered as too risky.
Never ever trade without using stops. Use of stop loss is must in each trade. First put a stop loss and only then enter the 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, take rest!