Every
time you trade, you’re exposing yourself to the risk of losing money. How do you
minimize that risk? You need to find a good setup and manage the risk with proper share size
and stop loss.
Here is my next rule:
Rule 5:
Success
in day trading comes from risk management - finding low-risk entries with a
high potential reward. The minimum win:lose ratio for me is 2:1.
A good setup is an opportunity for you to get into a trade with as little risk as possible. That
means you might be risking $100, but you have the potential to make $300. You would call that
a 3 to 1 profit-to-loss ratio. On the other hand, if you get into a setup where you're risking $100
to make $10, you have a less than 1
risk-reward ratio, and that's going to be a trade that you
should not take.
Good traders will not take trades with profit-to-loss ratios of less than 2 to 1.
It means if you
buy $1,000 worth of stock, and are risking $100 on it, you must sell it for at least $1,200 so you
will make at least $200. Of course, if the price comes down to $900, you must accept the loss
and exit the trade with only $900 ($100 loss).
If you cannot find a setup with a good profit-to-loss ratio, then you should move on and keep
looking for another trade. As a trader, you are always looking for opportunities to get low risk
entries with big win potential. Being able to identify setups that have big win potential is also
part of the learning process. As a beginner trader you may not be able to differentiate between a
range of setups. It may be difficult for you to recognize what is a home-run Bull Flag and what
will end up being a “false breakout”. That’s something that comes with both experience and
training. We will cover this in more depth in the coming chapters. You can learn from videos on
YouTube and Google. You can also join our private chatroom (free to you) in
www.Vancouver-
Traders.com
where I explain my trades in real time while I am trading them. You will be able to
observe me and my monitor and my trading platform.
Using a 2 to 1 win:lose ratio, I can be wrong 40% of the time and still make money. Again, your
job as a day trader is managing risk, it is not buying and selling stocks. Your broker is buying
and selling stocks for you in the market. Your job is to manage your risk and account. Whenever
you click “buy” in your trading platform, you expose your money to a risk.
How do you manage that? You essentially have three steps in managing risk. You need to ask
yourself:
1. Am I trading the right stock?
Chapter 4 focuses on finding the right stocks for day trading. I will explain in detail how to find
stocks that are suitable for day trading and what criteria you should look for in them. You must
avoid stocks that (1) are heavily traded by computers
and institutional traders, (2) have small
relative
trading volume, (3) are penny stocks that are highly manipulated, and (4) don’t have
any reason to move (no fundamental catalysts). I will explain these in more detail in Chapter 4.
Do remember that risk management starts from choosing the right type of stock to trade. You
can have the best platform and tools
and be a master of strategies, but if you are trading the
wrong stock, you will definitely lose money.
2. What share size should I take?
One share, 10 shares or 100 shares? What about 1,000 shares?
This depends on your account
size and your daily target. If you are targeting $1,000 a day, then 10 or 20 shares might not be
enough. You either have to take more shares or increase your account size. If you don’t have
enough money to trade for a $1,000 daily target, you should lower your daily goal.
I am holding around $25,000 in my trading account and I usually choose 800 shares to trade.
My daily goal is $500 or $120,000/year. That is sufficient for my lifestyle. What is your trading
goal?
3. What is my stop loss?
The absolute maximum a trader should risk on any trade is 2% of his or her account equity. For
example, if you have a $30,000 account, you should not risk more than $600 per trade, and if
you have a $10,000 account, you should not risk more than $200. If your account is small, limit
yourself to trading fewer shares. If you see an attractive trade, but a logical stop would have to
be placed where more than 2% of your money would be at risk, then pass on that trade and look
for another one. You can risk less, but you should never risk more. You must avoid risking more
than 2% on a trade.
