Most day traders know about limiting the risk of their trades, but capping daily losses is a practice traders could also benefit from. By capping risk on each trade and day, the trader is taking steps to make sure that no single trade or single day ruins their month, or worse yet, their account. To become a successful trader, try to think like a trader who already is successful–and who therefore relies on his trading account (capital) to make an income every month in order to live. When a trader loses a large chunk of capital it should feel similar to how most people would feel if they got fired from their job. Limiting risk, on each trade and on a daily basis, can help avoid this uncomfortable situation and feeling.
Strings of losses occur. Even following a great system, and having a keen market insight will result in a number of losers in a row at some point. That’s just the way it is. If you risk too much on each trade though, a small string losses can wipe out an account.
Only risk 1% to 2% of your capital on a single trade. This way no single trade will ruin you. See Determining Binary Options Position Size for a detailed description on how to manage trade risk in this way.
While capping the risk on your trades is important, so is capping the amount you can lose in a day.
Let’s assume you trade for a month (20 trading days), making a profit of $2000. On average you made about $100/day; some days you lost, some days you made less than $100 and other days more, but that is the average. You have a weekend off, feeling good about last month, and then proceed to lose $500 on the next trading day.
Change these numbers to suit your personal circumstance, but the point you should take home is that this daily loss is out of whack with the average daily profit.
It will take five normal days just to make back that single daily loss. This shouldn’t happen.
I recommend a floating daily stop, or a consecutive-loss-daily-stop (quite a mouthful).
A consecutive loss daily stop is when you define how many trades you are willing to lose in a row before calling it a day. If I lose three to four trades in a row, I am not in the right headspace, my strategies aren’t suited to the market or something else is doing on. In any event, I stop trading. I don’t want to waste more money than I have to on a day that isn’t showing me the type of price action I want.
A floating daily stop is a bit more complex. It is based on your average daily profit over the course of the most recent 20 to 30 trading days. If you made $2000 over 20 trading days, your average daily profit is $100. Therefore, keep your maximum daily loss near this figure–between $100 and $125.
This is a simple approach to get you started. To get more precise, take an average of only your winning days. By not including the losing days in the average, you may be making $175 on your profitable days. This is also an acceptable daily stop level.
The idea is to make sure your losing days don’t greatly exceed how much you make on profitable days.
By capping your daily loss at roughly the same amount as your average profitable day, you make sure that no single day significantly hurts you. If you follow this rule, any money you lose one day can easily be recouped on an average winning day.
Managing trade risk is important, but so is managing your daily loss. Instill a daily stop loss on yourself, so that one (or several) losing day doesn’t jeopardize your trading. If you lose three or four trades in a row, stop trading for the day. Also, specify the maximum amount of money you can lose in a day–based on your daily average profit–and then stick to it. Just like you don’t want one trade to ruin you, you don’t want one day to ruin you either.