Day trading is a serious endeavor that shouldn’t be taken lightly. As a day trader you are competing against professionals, algorithms, and large trading firms for profits in the markets. If you hope to make money you will need to operate like a business and not like a gambler. Success in day trading will require planning, speed of execution, and emotional discipline to compete.
Let’s look at the five biggest mistakes that new traders must avoid if they want a chance to be successful, which is measured by profits.
1. Day trading with no plan.
A day trader must have a plan on how they are going to execute each trade in real time. Day trading plans should be created when the market is closed to be followed while the market is open. A trading plan creates the speed of execution as you know what to do immediately based on the market price action.
The elements of a trading plan:
1. Entry signal: You must know clearly at what price you plan to enter your trade. Will it be a breakout from a price range, a bounce off support, a specific price, or based on indicators? You must be precise on what signals you get into a trade on the intraday chart.
2. Exit signal: Quantify when you will get out of a day trade. Will it be at a loss of support, a profit target reached, a specific price level, by using a trailing stop for a winning trade, or a stop loss for a losing trade? Know where you will be getting out before you ever get in.
3. Stop placement: At what level will you know you’re wrong about the trade? You must either have a mental stop, a stop loss entered, or a time stop.
4. Position sizing: You must determine how much trading capital you are willing to risk on any one trade before you decide how many shares to trade. How much you are willing to risk if your stop loss is triggered will determine how much you can buy, based on the stock price and volatility.
5. Risk management parameters: Plan how much capital you are willing to lose if all your open trades go against you at the same time. If you want to avoid the risk of ruin, never risk more than 1% of your total trading capital on any one trade. This is the percentage of trading capital you would lose if your stop loss is triggered based on your position sizing. If your position sizing is 20% of your total trading capital and your stop loss is 5% of your entry price then that would be a loss of 1% of your total trading capital.
6. Watchlist: Trade markets and stocks you are comfortable with and understand. Day trading requires stocks in play and on the move that give you enough of an intraday range to work with. Day traders must learn what types of stocks they need for their strategy to work.
7. Day trading time frames: A day trader must choose the intraday time frame they will be trading within. Will you trade only the opening hour, or the first two hours after the open, all day, or just trade the open and the close? Pick you screen time based on your strategy and what you need to execute your strategy.
8. Backtesting: Some day traders use backtested strategies where they mechanically trade repeating patterns on the intraday chart that have an edge historically.
9. Risk vs. Reward: Enter high probability day trades where you are risking $100 to make $300 based on your stop loss versus your profit target, this is a 1/3 risk to reward ratio. Day trade a system that wins big or loses small based on your trade management.
Regardless of how you trade, every day trader must have a trading plan or what they are doing is just random.
Once in a day trade the trading plan should not be changed. A trading plan creates discipline of execution. Wanting to change a plan during live day trading is usually due to emotions, loss aversion, or your ego trying to prove you are right by not exiting with a loss. Create your trading plan when the market is closed so you can execute day trades quickly when the market is open. Speed is an edge for day traders and indecision is a risk on the intraday chart.
2. Trading too much.
In most professions working more hours and doing more things increases income. If you’re paid for your time the more you work the more money you earn. This work ethic does not transfer into day trading. Overtrading can be expensive in trading losses, losing in the bid/ask spread, and commission costs. The best day trading can be when you are patient and wait for the right entry signal and set up. More day trades rarely mean more profits, it usually means overactivity and the inability to walk away from the screens after wins or losses.
Your trading plan should set the parameters for your trading time period for each day. Your signals should filter when you will be taking action or waiting. Overtrading is almost always due to greed or boredom and trading outside your predetermined plan. Many successful day traders have the ability to trade the open, make money, and then walk away from their screens for the rest of the day.
3. Trading too soon.
You want to learn how to make money in day trading first on a simulator and with backtesting strategies and not by losing money. Day trading requires speed of execution and knowing your platform. Trading with a demo account first is a great way to learn your way around how to exit and enter trades quickly and how to use hot keys. You also need the stats of how your signals performed in backtesting or with execution simulator to forward test and verify the robustness of your strategy. Pilots learn in simulators before flying real planes to avoid costly mistakes and a simulator can do the same for day traders.
It’s much cheaper to make your mistakes in simulators or backtesting software than with real money in the markets. Day traders must master both their signal identification and the speed of their execution before they go live and compete in the markets.
4. Trading too large a position size.
Your position size is like a volume dial on your emotions and ego. New day traders will be surprised at how different it is to trade real capital versus system development when no money was at risk of losing.
New day traders should start with small accounts so they learn their lessons through small losses. It’s smart to first go live with real capital at the smallest possible amount that’s still meaningful so you learn about managing your own emotions and ego. You want to learn the first lessons about your own mental and emotional weaknesses as a day trader by losing as little of an amount of capital as possible at the beginning. Keep your tuition fees to the market as a beginner as affordable as possible.
When you are starting out as a new day trader: “Trade small because that’s when you are as bad as you are ever going to be. Learn from your mistakes.” —Richard Dennis
5. Trading with no edge.
Many traders don’t understand what it means to have an edge in trading. An edge is simply an advantage in the markets that over time allows your winning trades to add up to more than your losing trades. There are potential edges day trading in every market, the hard part is both finding them and then trading them with discipline. An edge is where you profit from the mistakes of others.
If a day trader has an edge, they have an advantage that makes them more likely to be profitable than the average market participant. The profits from an edge come most of the time from the mistakes, emotions, egos or inexperience of other traders and investors.
Backtesting trading signals or developing a discretionary rule-based strategy that creates big wins or small losses can give a trader an edge over those that trade randomly or based on their own emotions. An edge is any type of advantage that can lead one person or system to outperform others over time and lead to profits.
A day trading edge is an approach that creates an advantage of any size or magnitude over the people you are trading against on the intraday chart. It doesn’t need to be fancy or complicated, just something that optimizes profitability by maximizing wins and minimizing losses. An edge creates profits when it’s allowed to play out consistently over time because it has a positive expectancy.
If you don’t know what your day trading edge is, then you don’t have one. If you don’t have an edge in the markets then you are just a gambler and will be donating your capital to others. It’s important not to confuse being a lucky gambler with being a great day trader.
As a day trader you must first develop a positive expectancy model, then position size correctly to survive losing streaks, and finally trade your system with discipline over the long term.