Alright, let’s talk about risk control. Day traders can control risk in a number of different ways, everything from written rules to rules programmed into trading systems to remove human emotion. The goal is to eliminate decision-making at the moment of a trade when emotions are running high.
Let’s discuss some of the best ways I know to control risk, the same control mechanisms I use when it comes to my trading strategy
Limited Margin
I don’t use any margin; I never use more money in any single trade than I have in my account. I don’t borrow money from my broker, plain and simple. If you don’t have enough cash to make the trade, don’t make the trade. You want to avoid any chance of a margin call.
Extensive testing
We’ll talk about paper trading later in the guide, but you must test your trading strategy and paper trade in order to evaluate the risk/reward characteristics of the trading decisions you make. Simple enough, test your trading before trading with real money.
Now how do I control risk when placing trades?
Let’s cover the four things that I do, that you need to incorporate into your risk control.
Stop loss orders
We talked about these earlier, stop loss orders are designed to limit risk by establishing a maximum (or expected) loss for a given trade. Although they are essential for controlling risk, again you must be careful to place them far enough outside of normal trading ranges to avoid triggering them accidentally and being stopped out of a trade.
Maximum daily loss
Establish a maximum daily limit for your losses in order to prevent your emotion from impacting your decision-making.
For example, if my first trade out the gate at the open is a loss of more than $100, I’m done trading. It might end up being a little more once commission and the whole position is sold, but as I get close to that number if I’ve made a mistake or something turned against me very quickly, I get out.
Since my daily minimum goal is $200, I want to keep my maximum loss to ½ of my minimum goal – I don’t want to worry about my state of mind if I try and continue to trade while having a loss on the day. I don’t recommend it.
Daily profit targets
As I just eluded my daily profit target is $200 a day (in other words this gets me close to $50,000 per year) This forces me to take gains and avoid taking on additional risks.
Some traders will continue to trade and call it trading on “house money” the money they’ve already won is all their risk.
I say what’s the point, time to wrap up, take my profits, and walk away for the day.
Monthly audits
Keeping a journal of your trades is a necessity. When you track them you can go back monthly, whether it’s your own spreadsheet or through your broker record online, and review your performance.
I do this to help me identify areas that I need to improve and ensure that I am not taking on any excessive risks when executing my trading strategies.
Basically, it keeps me in check and on task.
So you might be thinking by now, wow, these risk controls seem pretty obvious, and you’d be right, the hard part is adhering to them on a regular basis.
When it comes to keeping compliant you should always have a plan before you get into a trade. Having a plan means having a defined stop-loss point, a take-profit point, and asset rules for modifying the trade that can be referenced on a paper, the screen, or in your trade order window.
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