How can I limit my losses when Day Trading?

A successful trading strategy will take into account that even profitable portfolios include trades that lose money. Losses can and will certainly happen. To make an overall profit a portfolio requires an effective risk management policy relating to loss-making trades. It is equally as important to consider any emotional reaction to bad trades that might distort your approach to future trading.

Cash terms

Losses need to be thought of in both percentage and absolute cash terms. That creates a need to consider how much capital to allocated to any one trade. Trading in sizes that are a small percentage of your initial capital can still be profitable. Managing a trade effectively rather than being influenced by your emotional state is more enjoyable and is also educational. You may not make the much publicized 500% returns that some Day Traders claim, but by taking emotional issues out of holding a particular position, you can still return a profit that betters that of institutional investors. A lower risk-return profile to your trading will mean any losses will be smaller in absolute cash terms (see How profitable is Day Trading?).

Number of losers

Some trading strategies are designed to have a high percentage of losing trades. A Scalping trading strategy is one example where the risk-return ratio may be as low as 1:1 but importantly any losing trade will be limited in cash terms through the use of tight stop loss limits. A trading strategy based on Momentum would have fewer trades, each with stop losses that would cause more significant damage to your capital balance but (if your strategy is effective) less chance of being hit.

Risk management

The key to losses is to accept them. Do not move stop losses away from Price Action. Do not double down. Questions might be raised about the success or otherwise of any strategy you are using. That question is to be considered at an appropriate time, not mid-trade. It can be particularly frustrating to see a profitable trade give up its gains and then retreat to only break even, or worse, make a loss. Your strategy should factor in the benefits or otherwise of using trailing stop losses or bringing stop losses up to break even. Also, all your trading should consider the cost/benefit of using Guaranteed Stop Losses which mitigate the risks associated with Gapping Risk.

Losing streaks

Considering things from a higher level, if you are in the middle of a run of losses that are eating into your capital, it’s not a good idea to try to ‘normalize’ returns by carrying on trading until some as yet unseen factor comes into play. A run of losses might suggest you are trading too much and just churning out trades rather than following a strategy. There might be other factors to hand such as a paradigm shift in the markets that renders your strategy unprofitable. Always keep in mind that the option exists to take some heat out of the situation, to scale down and reconsider, or even stop trading for a while. You can also:
  • Trade in a Demo Account.
  • Trade in smaller/minimal sizes.
  • Trade a different strategy.
  • Trade a different product or market.
  • Trade on another platform to get a new perspective and use different analytical tools.