Assessing Risk in Day-Trading
Risk assessment is critical for success in any trading markets. If you risk too much and you win, everything is great. But the problem is that you have no way of knowing whether or not your next trade will succeed or fail. And if you risk you much and lose, the effects can be detrimental. It is never wise to put yourself in a position where your risks can have a bigger effect than your rewards, as this is a recipe for failure and can quickly destroy a trading account.
“The conventional wisdom is that you should never risk more than 2% of your account balance in any given trade,” said Rick Bartlett, currency analyst at CornerTrader . “But there is nothing wrong with risking less than this number.” In fact, for conservative or new traders, it is generally a wise idea to risk less than this upper limit figure because this will give you an added layer of protection and allow you to practice your day-trading strategies until they are fully formed. Professional traders will often risk less than this upper limit and many will actually elect to not use leverage at all in their regular trading activities. This shows the ability to exercise patience rather than greed — and this is a key ingredient for long term consistency in the financial markets.
In addition to this 2% number, a daily limit should also be implemented. For high frequency traders (traders that regularly input more than 2 trades per day), these additional risk rules become even more important. So while each trade might lose much less than 2% of your total account size, a large number of smaller losses should not be allowed to accrue because this might violate you 2% threshold level. This can be applied on either a daily or weekly basis, depending on your personal trading style. The main idea here is to keep a longer term perspective and to always be cognizant of your total losses (with a larger number of trades in consideration).
To put things into perspective, a trader can also place these daily or monthly loss limits as being roughly equal to your gain expectations for the same period of time. In other words, if you would expect to make about $150 over a certain period, then your loss limits should be less than or equal to this number. This prevents your daily (or weekly) loss potential from hurting your account too much in a small period of time. The reality is, there are many instances where losing days and losing trades can snowball and ruin your trading for the period. So to keep this from overtaking your trading account (and depleting its value), always remember to keep your leverage levels and position sizes to conservative levels.