As a Day Trader, it is impossible to always avoid losing money on a trade. When trading penny stocks, it’s even harder to avoid losing money due to the extreme volatility they enjoy. The same volatility that, when proper trading strategy is used, can bring you the 50, 60, 70, 100+% gains can also take it away from just as quickly and in just as large of chunks. But it doesn’t have to be this way. Some of the best advice I ever received was in order to be successful, you have to learn how to lose. How you lose will define your trading career and either end it or make it worth your time. Here are three ways to avoid large losses while day trading.
Don’t Just Jump In
Like anything in life, it’s important to have at least a basic level understanding of what it is you’re about to get yourself into. With Day Trading, it is very possible that you may hit the jackpot and buy in and sell at just the right time out of sheer dumb luck. When it happens, you feel like you are the master of the universe and the stock trading game is so easy.
But over time that luck will run out and you will lose. The first step to success, and an important piece to avoid large losses, is knowledge. Become a student of the game and spend some time really studying the basics. You can start here:
- A Quick Guide to Day Trading
- Why Support and Resistance Levels are So Important
- Learn the Basics: Candlestick Charts Explained
In order to set yourself up for long-term success, it is vital you put in the time to really learn what it is you’re about to do. Without at least a basic level of understanding you are not day trading, you are simply gambling.
Remove all emotions from the trading game and the game will come to you.
Know Your Target Entry and Exit
Once you’ve identified the stock you’re interested in buying, hopefully using support and resistance levels, you should stop for a moment and think about what your entry and exit points are. As you’ve probably heard, it’s important to “look to the left” before buying a stock. That simply means that you should look at the history and past days, weeks, months and even years to understand the characteristics of the stock.
- Is it a long-term riser?
- Does the stock have a history of pump and dumps?
- When the stock has a rapid climb does it usually sustain those gains or have regression?
These are the types of questions you should be asking yourself before buying so that you can have a baseline for what to possibly expect after you purchase. History often repeats itself but it doesn’t always repeat itself in the exact same fashion as before. So don’t base your entry/exit points solely on what has happened in the past. You should use additional indicators such as Moving Average or RSI to know when to get in.
Equally as important, to help avoid losses you should have an exit point identified before hitting the buy button. Personally, using historic resistance levels is a preferred, quick and easy method to use to identify a ballpark exit price. But you should also identify what percentage gain you’re expecting and plan for that. It’s really easy to say I want 100% gain on every trade, but it’s not realistic. Remember, professional traders are happy with a consistent 3-5% daily gain.
For beginners, a 5-10% gain is a very good target for your trades. Once you’ve identified your target gain percentage you should then calculate what that means in terms of the price of the stock so that way you know when you should sell.
Example: let’s say you want a 10% gain out of a trade and the stock price is $2. That means that you would sell that stock after it gains 10%, or $0.20 no matter what. Remember, removing all emotion from the day trading game will help you stick to your trading plan and remain consistently profitable over time and avoid large losses. It’s very easy to get caught up in the excitement of a stock climbing.
You may think, “Ok it climbed 10% but what if it climbs 20%! I’ll miss out!” You aren’t entirely wrong in this line of thinking. It’s possible that a stock could greatly surpass your target price and you could leave some money on the table by selling. However, it’s equally as possible that it hits your target price and then bottoms out and you end up selling for a loss or holding the bag for weeks or months.
Always take profit into strength.
Use a Stop-Loss
One of the most important lessons in Day Trading is learning how to lose. There is almost an art to minimizing losses, but luckily, it’s easily learnable. The use of a Stop-Loss can help eliminate your risk of financial ruin and even help ensure you take home some profit.
If you don’t know what a stop-loss is you can learn more about that right here.
Just as you should identify an entry and exit price prior to buying a stock, you should also identify what your acceptable loss is. This may be the hardest part for many traders because nobody buys with the intent of losing money. But it’s simply part of life for day traders and the quicker you can understand and accept that it will happen to you, the quicker you will avoid large losses.
Let’s use the example above:
You are about to buy a stock that costs $2 per share, with a 10% gain target. You are comfortable with losing $0.10 a share, or 5%. In this instance, you would buy the stock and immediately set a stop-loss order at $1.95. If the stock continues to climb, great. You can cancel the stop-loss order and sell with a limit or market order. But if the stock takes a turn and falls off the face of the earth, your stop-loss will protect you from losing more than you’re comfortable.
As a Day Trader, you can boil your job down to one simple task: to build wealth. Losing on trades is an undeniable part of trading stocks. It’s important to accept the fact that you will lose money. But the strategies that you put in place and the rigor with which you implement these strategies will ultimately determine how much you lose. By avoiding or minimizing large losses, you can remain a consistently profitable trader.
Keep this motto in mind: When you win, win big. When you lose, lose small.