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Evaluating Risk Management in Stocks

When buying or selling stocks on any exchange for any length of time, there is risk involved. Whether you are day trading on the minute, or investing in stable funds for your retirement, understanding the upside and downside of your investments is the first thing you should assess before entering a position.

For short term trading, this is especially important as you are likely using capital that will be functioning as a trading bankroll. This means big losses will damage your short-term growth opportunity. As such, we also recommend figuring out a risk management strategy so that one or two bad trades do not hamper your account badly.

Short-Term Trading for the Long-Term Investor

As with most sound investment strategies, day trading isn’t a get-rich-quick scheme, despite what it is sometimes portrayed as. The goal of day trading is to create a system where you can make a series of short moves day-to-day that add up to create financial freedom over time.

Because stock trading in narrow windows of time can have sharp movements up or down, traders should be looking to make good entry points at stock prices that allow for upside. From there, the goal is to have a win rate on each stock that you have mapped out in your trading plan, take the profit, and target the next move.

A common mistake that even experienced traders make is letting their emotions get the best of them during a trade. This can happen by buying into a stock that is overextended, holding a stock past a small loss and letting it turn into a large one, or not selling with a comfortable profit and letting it dwindle away.

Ultimately, your plan needs to fit your bankroll and goals, and you need to stick to it as often as possible.

Win Rate and Trading Capital

Regardless of how much money you are willing to put at risk, you should be looking to make trades on a percentage basis, not lump sums of money. It is fine to have a goal such as making a certain amount over a period of time, but it is unlikely that as a day or swing trader you can accomplish that in one or two trades.

Thus, you should figure out a comfortable amount of your portfolio to risk for your relative certainty in a trade. For new day traders looking to avoid volatility, we recommend that you do not risk more than two percent of your cash on each trade. This is generally referred to as the two percent rule.

This means if you have $1,000, your first trade should be $20 worth of stock, and you should be looking to make $1 on it (a 5 percent return, which is a good day trade return). While these numbers may be higher or lower than your initial investment amounts, and you can calibrate your risk/reward differently, the overall premise of protecting your capital remains the focus.

Money Management Rules for Stock Trading

Having established what a criterion for single trades is in terms of your starting position, there are a few more things to consider in terms of managing your capital.

1)    Don’t Force Trades

Deviating from your plan can cause disaster in a number of ways. Chasing stocks that have run up quickly is enticing, as it seems they will continue to rise, but you need to be very sure about trades in that circumstance. FOMO is real in stock trading, and ill-advised.

Another form of forcing a trade is taking a position after a bad loss because you want to make money back quickly. This is called emotional trading, and whether it works or not, builds bad habits. Eventually, you will get caught in one of these and it will compound your first bad trade.

Always create a plan, and always trade your plan if possible.

2)    Do Your Own Research on Stocks

Part of having a good financial education and baseline knowledge about the stock market is being able to identify warning flags and positive factors. In the social-media age, there are people promoting their trades at every corner of the internet; Twitter, Reddit, and Discord are all well-known for having trade groups. While they can provide some baseline ideas, they often have ulterior motives to get people to buy heavily into securities they already own.

Instead, we suggest investing your time in how to learn the technical aspect of trading stocks: reading financial disclosures, recognizing chart patterns, and knowing how to use a scanner. That way, when the masses start putting out great stocks that can take off, you’ll be one step ahead of them.

3)    Trade Your Plan

This term will come up over and over in our lessons. This means you should be identifying whether you are intraday trading a stock, swing trading, or investing long-term. Similarly, you should have relatively finite targets at which you plan to begin selling out of your positions. The more experienced you get, the more fluid these things can be, but as a beginning day trader, we recommend making sure you can fulfill attainable goals with each trade.

4)    Manage your Bankroll Seriously

This is a combination of multiple trading tenets, but they all must be applied. Don’t take larger positions out of hype or frustration. Do not trade with money you cannot afford to lose. We recommend starting with a set amount and not adding to it so your results will predicate your bankroll growth.

It is easy to get caught up in moments or the results of short term trades, whether good or bad. The reality is that that serious trading should be viewed as one long-term plan, with thousands of decisions pieced together to make a consistent profit.

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Riskier Investing

Once you have mastered basic risk management in your beginning portfolio, it is natural to look at more aggressive trading strategies. These could include trading the following:

  • Options: Options are ways to leverage small amounts of initial capital into exponential gains (or losses, which is why you have to be careful). An options contract allows you to buy or sell a security at a predetermined price over a set period of time. You can hold through these times, or sell as the likelihood of meeting that price occurs (which can make the contract worth more). Options plays are very volatile, and we recommend waiting until you are an experienced trader to begin looking into them.
  • Cryptocurrency: Bitcoin is the famous powerhouse of cryptocurrencies, but there are hundreds you can trade on many brokers. These coins all essentially act as their own securities, and fluctuate in the same way as publicly traded stocks. There will be a different set of catalysts to analyze for their price movement, but there is money to be made by savvy traders in crypto.
  • Foreign Exchange: Forex is another volatile niche trading market that you can engage in once you have mastered the basic mechanics of day trading. These markets are open 24-7, and are a marketplace for exchanging foreign currencies against one another. These are all over the counter, meaning there is less regulation of it than the normal stock market, so be advised when looking to get into Forex.

Be More Profitable with Day Trading

The goal of day trading is to make money each and every day if possible. Emotions like greed, fear, and confusion will all get in the way of accomplishing this task. Once you have mastered the nuances of a trade plan, removing your emotions from trading, and managing a bankroll properly, you will have a skill set that can return profits repeatedly. StockAbility™ has been providing insight on all these topics for decades. Our training courses have helped beginning traders get acclimated without having to suffer massive losses as a learning experience. If you are looking to invest in yourself and your future, register for one of our upcoming webinars.

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