Day Trading Money Management

By Jared Erni

December 16, 2009

Day trading can be a very profitable business. Some may even argue that it can be one of the safest forms of investing because you are only focusing on a small number of positions, you are not holding any positions overnight, and you are able to enter and exit trades with pinpoint accuracy. However, many day traders find that they cannot control their losses. This generally doesn’t have anything to do with their trading system. You see, the weakest link in any trading system is the trader himself. Many day traders find themselves losing due to poor discipline and money management.

From personal experience, the most difficult hurdle in day trading is learning to master yourself. As humans, we are programmed to make decisions with our emotions and then find logical reasons to justify our decisions. If you trade with this approach, you will lose; but too many traders either never understand the importance of trading psychology or choose to ignore it all together.

Let me discuss one tip that I have found extremely relevant from my personal trading. Paul Tudor Jones, founder of Tudor Investment Corporation, once said, "I’m always thinking about losing money as opposed to making money. Don’t focus on making money, focus on protecting what you have".

Trading is exciting and provides a thrill almost as intense as any extreme sport; the rush of adrenaline, the highs and lows. If one is not careful, they can easily cross the line from calculated risk to gambling. This is when trading becomes dangerous.

Here are a few tips for good day trading money management:

1. Do not risk more than 2% of your total equity on any given trade. This is a simple safeguard, but can be difficult to follow when greed sets in. As your account equity grows, you will likely be able to risk less than 2% of your total equity. By following this simple rule you will be protecting what you already have.

2. Identify your profit target and acceptable risk before entering a trade. Some have used the phrase "Plan the trade, then trade the plan". If you know what you are going to do before you do it, you take an element of the emotions out of the mix. This rule will help you execute your trades objectively.

3. Use limit orders to enter trades. A limit order specifies the exact price that you are willing to buy. Your order will only be filled if that price is made available by a seller. When using limit orders, you may occasionally see some of your orders not get filled, but when you are dealing with short inter-day trade, you can’t afford to give up portions of your profit to slippage.

4. Enter protective stop order on every trade. This is sometimes referred to as a stop loss by setting a stop order at the level you are willing to risk. You must be prepared to exit the trade and cut your potential loss just in case the trade goes against you. This rule is a protective measure. But remember, you don’t have to let the trade take you out at your full stop loss. If you know the trade is bad, cut your losses short as much as you possibly can.

5. Set sell orders at your target price. Once you have entered the trade, you should place a sell order at your profit target. You want to be ahead of the line to sell when the price hits your profit target.

6. Exit all your positions by the end of the day. The single biggest mistake novice day traders make is to fail to be disciplined. Don’t take on unnecessary risk by holding positions through the night or trading during off hours. Only trade during market hours with a comfortable market rhythm and activity.

Day trading can be a profitable business and rewarding living, but traders must learn the key to their success is hidden within themselves. Be disciplined, manage your money wisely, and protect what you already have. Happy trading.