Stop Loss Strategy for Day Traders

Setting up a stop loss level should be easy, but how is the case for day traders? Is there any specific condition that you need to mind for daily stop loss?

Risk management is a general concept that any trader should know, including a day trader. Essentially, there is no definite rule that you should follow because every strategy and market condition requires different actions and plans.

Stop loss is one of the easiest tools that you can use to reduce the risk. Typically, stops are placed around the current support or resistance levels. You can use both volume and price to determine that.

It's generally better to set the stops quite wide, but also make sure it's not too wide. The reason is that tighter stops tend to push traders to overtrade and left only a tiny room for the strategy to work. Some strategies need time to "cook properly", so it's best to give the trade a chance before you bail.

Moreover, many traders recommend setting the risk at 1% for a single trade. That means, if you have a $10,000 balance on your account, you should set a stop loss on each position so you don't lose more than $100 per trade.

The idea is that by setting the risk so low, your balance won't be significantly affected by a price movement that goes against your favor even if you open several positions a day.

But, if you set let's say, 10% loss on each trade like many rookies do, and end up losing a few trades in a row, then your account will get a massive cut and you'll suddenly find that half (or more) of your money is gone.

However, remember that the 1% rule is not absolute for all strategies. You can adjust the amount depending on the winning percentage of your strategy.

Day Trading Stop Loss

Apart from managing the risk on each trade, it's also crucial for day traders to manage the risk on each day by using a daily stop loss. The daily stop loss refers to the amount of money you're willing to lose in a day before you quit. This is entirely separate from the stop-loss order that controls the risk of an individual trade.

The main goal of daily stop loss is to prevent a single day from damaging the entire monthly income. For example, your average winning day is $200; on a losing day, you lose $600. Under such conditions, you barely break even if you win about 80% of trading days.

For this reason, if you control the loss you can afford daily, you could hugely reduce the amount you lose on bad days, creating a consistent monthly income as you originally planned.

Being a day trader means that sometimes it's necessary to admit that some days are not your day, and preserving your capital for another day is the best option.

When the losses pile up, it can become tough to stay focused and not get into the "revenge trading" mode. It's when you abandon your original trading rules and try to gamble for quick profits to cover the previous losses, which typically results in even bigger losses.

How to Use Daily Stop Loss

Before the day begins, set the daily stop loss, and it's even better to write it down in your trading journal. The daily stop loss for each trader is different, but in general, there are a few ways to do it.

If you are new to day trading and still don't have any track record, you can determine your daily stop based on loss percentage or the number of losing trades in a row. Both of these methods are ideal and applicable.

1. By Loss Percentage

In general, if you risk 1% per trade and it turns out that you lose 3% of your account in a day, it is bad news, and you should call it a day. The same action should occur if you lose three trades in a row (you may adjust this to your trading style). Stop trading immediately, or take a break for approximately 10 minutes if you're frustrated.

If you risk 0.5% for a single trade, set a daily stop loss limit of 2-3%. This gives more leeway, so you can get 4-6 losing trades in a row before being stopped out. Remember that the 3% rule is your maximum loss for the day. You can lower the amount but try not to lose more than 3% daily.

2. By the Amount of Daily Profit Average

Now if you do have a day trading track record already, you can use the dollar amount of your daily profit average to determine your stop loss level per day.

You can do this by adding up your profits on only the profitable days in the last month and then dividing it by the number of good days. Your stop loss should be around that number.

For example, if your daily profit average is $100, you shouldn't be willing to lose more than $100 on a losing day. Remember that this method means the stop loss level can change with your performance over time.

It is very good because you can ensure that any losing day can easily be covered by a profitable day so that it won't leave significant damage to your account.

This system allows you to recover from your losses rather quickly, which is a much better option than doing "revenge trading." After all, occasionally getting losses is very normal to any trader, so it's best to prepare beforehand.

In addition, you can also add a buffer to your trade, say 50%.

Therefore, if your average profitable day is $100, you can set your daily stop loss to $150. If you hit your daily stop loss (lose $150 or more), getting the same amount back will take about a day and a half of profitable trading.

This added buffer will give you more room to make back some money during the day without being forced to quit immediately. However, remember that the buffer should be added in advance.

Additional Tips on Using Stop Loss

Risk management is one of the most vital aspects that traders should understand daily. If you don't plan it properly, a single losing day can significantly cut your balance and affect your monthly income.

One key to being a successful trader is ensuring you win more on a winning day than you lose on losing days. A daily stop loss can help you achieve that by ensuring you won't get a massive loss in a single day.

You may choose a daily loss level based on a loss percentage or the amount of your average profit on a winning day. The latter means that the limit will vary over time depending on your performance in the previous month.

If you're still new and have no trading record, you may also choose to stop trading if you lose a couple of trades in a row or a certain percentage of your account.

Remember that daily stop loss should be the last resort of your trade, which would force you to stop trading and quit the market for the rest of the day.

That being said, hitting your daily stop loss should be a rare occurrence, perhaps only once a month tops. If you keep hitting your daily stop loss, your strategy probably needs more work. Test your strategy on a demo account before investing real money in the market.

Lastly, to avoid making the same mistake repeatedly, you should keep a trading journal and analyze your trade from time to time. Write everything down and try to look for a pattern that made you win or lose regarding stop placements. Remember that the market condition is different each day.

Some are more volatile than others, some are extremely busy, and some are quieter. Such conditions will determine where the stops should be placed. The market's unpredictable nature emphasizes the need to use stop loss even more to reduce the risk of trading.

Never underestimate what one losing day can do to your monthly performance; always prepare a robust risk management system.