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Daily Stock Tips Free Report #5:
Five Money Management Tips for Day Trading
Day trading requires a different psychological outlook than either long
term buy and hold or even intermediate term swing trading. The day trader
is looking for a quick $1 or less profit that occurs in a matter of
minutes or hours. In others words, a day trader looks to succeed by
accumulating a series of "singles" rather than expecting or waiting for a
"home run."
With this in mind you can understand why money management discipline is
even more critical to trading success for a day trader than for longer
term traders. For example, assume that a day trader makes 10 trades. No
one is going to be right all the time. If your day trading system is going
to be successful it will need to be correct at least 70% of the time. That
means if you make 10 trades, 7 of the 10 must be profitable.
What happens all too often for novice day traders, and why the pool of day
traders is ever changing, is that they may very well make 7 successful
trades and rack up a total profit of $7, or $700 if they trade 100 share
positions each time (minus commissions). But if they are not minimally
disciplined on the 3 losing trades, it is very possible to give back all
the profit of 7 profitable trades. For example, losing only $2.50 per
trade for 3 trades yields a total loss of $7.50 or $750 for 100 share
positions (plus commissions).
1) Identify Profit Target and Acceptable Risk BEFORE You Trade
Evaluating risk and acting to limit losses is critical to success.
There are few other endeavors in life where you can be right 70% of the
time, yet wind up losing!
It is vital that you understand the math here. If your profit target is $1
for each trade and you expect to be profitable on 70% of your trades, you
cannot risk more than $2 for each trade. This is because if you hit 7
profits and accumulate $7 profit, then lose only 3 but lose the maximum
risk of $2 each time, your loss will be ($6) but when you factor in
commission costs you will be about breakeven.
Therefore you need to reevaluate your risk strategy. If your profit target
is $1, then you should not risk more than $1 each time. This is easy to
say but more difficult to do. the key rests with the accuracy of your
trading system. If you are accurate 70% of the time (and that is the
minimum to consider day trading), you can make money risking $1 to make
$1. Be sure to back test your trading system though to make sure it meets
this standard.
So the first money management rule of day trading is to never risk more
than your profit target. If your target is $1, then risk only $1. If your
profit target is $1.50, then risk no more than $1.50. You MUST exit your
trade every time it reaches your preset maximum risk. As strange as it
sounds, the only way that you will ever profit consistently day trading is
to have the iron discipline of accepting the inevitable losses.
2) Use Limit Orders to Enter Trades
The second money management rule for day trading is that you must enter
trades using limit orders only. A limit order specifies an exact price
that you are willing to buy. Your order will only be filled if that made
price is available by a seller.
If you are looking at holding a stock for years or even weeks, a 10 or 20
cent difference in price is not significant. Longer holding periods
require that your profit target be much higher. But if your profit target
is $1, a 10 cent difference in execution price is 10%. A 20 cent
difference reduces your return 20%!
There are two primary orders for buying a stock. A "market" order means
that the buyer is willing to pay whatever is being demanded by the seller
when the order hits the floor. The floor broker has no discretion in
filling the order. He must pay the "market" price. Even in the most active
stocks, the spread between the "bid" (the highest price a buyer is willing
to pay) and the "ask" (the lowest price a seller is willing to accept) is
often 10 to 20 cents.
Never buy with a market order when you are day trading. It makes you
subject to the whims of the floor traders, and they make their money
skimming 10 to 20 cents time after time from public orders. Always enter
your trades with the price specified. Don't let the floor traders take
advantage of you. Use limit orders exclusively to enter orders.
3) Enter Protective Stop Orders on Every Trade
Identifying the risk you are willing to take on any individual trade is
only the first
step in disciplined trading. You must be prepared to exit your trade and
cut your potential loss just in case the trade goes again you. The best
method for ensuring that you follow this discipline is to enter a sell
stop order at the same time as you enter your buy order.
A sell stop order is placed below your limit order. For example, say you
decide you want to buy XYZ at 30 a share. You call tell your broker to buy
100shares of XYZ at $30 limit. That means you will only pay $30 per share
or less.
At the same time enter a sell stop order at $29. A sell stop order is
triggered if the price of XYZ drops to $29. It then becomes an automatic
sell order to sell your position. The sell stop order "protects" you
against larger losses.
4) Set Sell Orders at Your Target Price
Once you have purchased a stock with a limit order, you should
immediately enter a
sell order at your profit target. You want to be at the head of the line
to sell as soon as it hits your profit target. If you wait until it hits
your price, there will be an unavoidable delay in the time you contact
your broker and the time the order gets to the floor. Day traders must
take profits aggressively.
5) Exit All Your Positions by the End of the Trading Day
The single biggest mistake novice day traders make is to fail to be
disciplined. Day
trading means you intend to complete your trade within a day. The
advantage is that you never have overnight risk. Be disciplined. Never
fall into a false sense of security. Get out of all your day trades
positions by the end of the trading day. Carrying over positions to the
next day increases your risk potential. Overnight news often causes wild
volatile high risk opening prices which can cost you plenty of money.
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