When learning to trade, many beginners put a lot of emphasis on finding the right entry point. But it’s equally important to know how you will exit a trade. The LPP can help you get started on the basics.
This is especially true for day trading. To make money, you must be able to quickly and accurately execute on short-term positions while also managing your risk.
1. Observe the Market
Many people are tempted to try day trading, hearing stories of friends or family who have gotten rich quick. While there are rare examples of this, it is more common to hear about day traders ruining their lives and financial situations.
To avoid this fate, you must be willing to learn about the market, understand it and stick to your plan. It is also wise to take the time to practice your trading strategies in a simulator before risking any money. It’s a good idea to create a trading journal that includes screenshots of your trades (at the point of entry and exit), along with entries, stops, targets, technical notes, and any other pertinent details. This journal will be helpful when you want to review your trades at a later date.
One of the biggest mistakes that new traders make is to get greedy and aggressively “chase” a breakout, hoping that it will continue upward momentum. This can be a recipe for disaster, particularly if the price is not able to sustain the high level. It is also a bad idea to use leverage or borrow money to buy stock. This is called buying on margin and it’s a sure way to lose everything you have.
A common strategy for day trading is to identify a strong trend and wait for it to retrace or pull back to a support level. Then, the trader will look to buy in the area of that support. By doing this, the trader is attempting to capitalize on the “abnormally high volatility” that is associated with these types of moves.
2. Keep Your Eyes Open
While many people who start day trading are excited about their potential to earn big bucks, they tend to focus much of their energy on how to spot the best entry point. This is understandable, as entries are a critical part of any trading strategy. However, it is just as important to focus on exits. In fact, it is often more important.
If a trade turns against you, it is essential to know how to get out of it, no matter what the market conditions. You need to set a stop loss, and it should be determined ahead of time by using technical analysis on a short-term chart. For example, a good way to determine your bailout point would be based on the average of the highest lows over the last several candles.
This is a very important step, as it can help you avoid costly mistakes. It can be tempting to try and recoup losses by aggressively chasing a breakout, but this is usually a losing proposition. It’s better to wait for the price to retreat slightly and then buy in at a more sensible level.
Another issue is the high costs of day trading. There are commissions, tools, and training expenses to take into account, and they all add up quickly. As a result, you need to generate a certain return on your investments just to cover the costs. If you can’t do that, it may be necessary to reduce your position size or even cut your losses. This is a very difficult thing to do, and it is why so many new traders lose money in the beginning.
3. Set a Stop Loss
Whether you trade on your own or with an investment firm, it’s important to never buy stock with money that you can’t afford to lose. This is known as “buying on margin.” It’s a dangerous practice that can easily lead to bankruptcy if you aren’t careful. It’s also a good idea to never borrow money to make investments or day trades. Investing with borrowed money is a sure way to go broke, and you could get banned from trading if the Financial Industry Regulatory Authority (FINRA) finds that you have made four or more day trades within five business days.
One of the most important things to do when establishing your trading plan is to figure out how you’re going to exit losing trades, and how you’re going to protect profits on winning ones. You can accomplish both of these tasks by setting a stop loss and a target for each trade.
A stop loss is an order that tells your broker to exit a trade at a certain price if it starts losing too much. There are several different ways to set a stop loss, but the most common is the percentage method. This tells your broker to risk no more than 1% of your total account equity on any single position. If you have a $10,000 account, this means that no more than $100 can be lost on any given trade.
Another popular option is the trailing stop loss, which moves at a specified distance behind your market price. For example, on a long trade, a trailing stop will rise as the price of the asset rises, but will stay at a pre-set distance if it begins to fall.
4. Set a Target
A successful day trader is able to find stocks that are poised for upward momentum. This may be due to a recent earnings announcement, a company’s plan for expansion, or even just a strong market trend. They also seek to make multiple profitable trades per day, often leveraging their trading accounts with margin for larger returns. This is a different approach from investors, who tend to invest for the long term and focus on their annualized returns rather than day-to-day performance.
One of the biggest challenges for new traders is to learn how to properly manage their risk. In order to do this, they need to know how much they’re willing to lose on each individual trade. The best way to do this is to calculate their potential risk/reward ratio. This is the amount they’re willing to risk compared with the maximum profit they expect to make on each trade.
For example, a new day trader might decide to only risk 1% of their investment capital on any one single trade. This will help prevent them from losing too much of their money and allows them to continue trading if their first trade doesn’t turn out to be a winner.
Another important step is to set a target for their trading account. This will tell them how much they want to gain from each trade, which will help them determine how many successful trades they need to reach their goal. This will also help them avoid making too many bad trades that can erode their profits.
Finally, they should consider whether they’ll be using a discretionary strategy or a systematic one. This will help them decide how much they’re willing to risk and will ultimately be a deciding factor in their success.
5. Manage Your Risk
Even the best day trading strategies can fail without proper risk management. This is particularly important for those who trade on margin, which involves borrowing funds from a brokerage firm to invest in a trading account.
Day traders need to know how much they can lose on a single trade and stick to it, regardless of the outcome. Choosing a profit target that’s at least double the amount you’re willing to lose on a trade is a good place to start. This will allow you to avoid taking unnecessary losses and keep your overall risk low.
You can also determine your risk through a formula, such as risk to reward (R:R). R:R refers to how big of a profit you want to see relative to the size of your risk. For example, if you’re using a stop loss order and a position sizing, you may decide that your risk will be 1 share per dollar of your capital.
To limit your exposure, you can choose to only buy a stock or ETF when it hits “support”—a price at which other buyers step in to buy and the stock is more likely to rise. Alternatively, you can sell when it hits “resistance,” a price at which other sellers step in and the stock is more likely to fall.
Whether you’re using a doji reversal, a momentum play, or another type of candlestick setup, it’s important to set a clear exit point for every trade. This can help you avoid chasing profits and keeping your trade too long. By having a plan for every position, you’ll improve your performance and build confidence in your skills. You’ll also have more time to make other trading decisions that can potentially lead to greater profits.