Daily Loss Limits – Protect Your Day Trading Account

As a day trader, you can not let a single bad day ruin your entire month. In this line of work, it’s inevitable that you’ll have really great days, really bad days, and plenty that are in between. However, profitable traders understand just how important it is that one single day does not blow up their account. A common risk management practice is setting a daily stop-loss limit, that way you can live to trade another day.

Understanding the Daily Loss Limit

The day trading daily loss limit is the predetermined amount of money that you are willing to lose in a single trading day before stepping away from the market. This loss limit acts as a psychological safety net, helping you recognize when the day’s trading conditions are not in your favor. Often when we try to fight a day that isn’t working for our strategy, it becomes easy to fall into the trap of revenge trading. This risk management tactic aims to prevent that.

A daily loss limit is not the same as a stop-loss order, which manages risk for individual trades.

Setting Your Daily Loss Limit

A daily stop loss limit can not be an arbitrary number. It must be based on your trading statistics and psychological tolerance to loss. If you are new to trading and don’t have a dataset of statistics for your performance, you’ll likely use a fixed percentage loss of your total account size or a specific number of losing trades.

A good baseline starting point could be no more than 5% loss of the account on a day and three losing trades in a row. This is a good start because we know that each individual trade can risk 2% of your account value. If you lose two trades in a row that’s 4% and one more brings you to your 5% and three losses before shutting it down for the day.

If you do have a dataset of your trading, which all traders should, then you’ll want to set a daily loss limit that is within the scope of what you can make back on any given day. For example if your average day is $1,000 your max daily loss should be no more than 1.5-2  times this amount. The idea is that you have a little bit of wiggle room but can quickly recover from a losing day and continue to build a positive equity curve.

Implementing the Daily Stop-Loss

Implementing the daily max loss requires the discipline to stick to the number or percentage that you have predetermined. A common practice is to write down your max loss on sticky note and put it on your monitor every day. You might not have to do this forever, but in the beginning it is a great way to have a constant reminder.

The sticky note method will also reduce the temptation of adjusting your max loss once already in a trade. It can be very easy to convince yourself that you’ll just hold a little longer, a little longer, and the next thing you know you’ve gone over three times your intended max loss. Remember, the whole point of a daily loss limit is to protect your account and prevent a single day’s losses from causing a blow up.

Some broker accounts allow you to manually configure a daily loss limit as well. They have a loss limit where once reached, you will be unable to place additional trades on the day.

Learning From Max Loss

Your daily max loss, or loss limit should be something that is hit fairly infrequently. It’s designed to prevent a bad day from getting worse. If you find that you are breaching your max loss on a regular basis, it might be best to re-evaluate the number and make sure that it’s not too small. Remember that trading comes with volatility. Not every loss is going to be a perfectly contained move. Making sure your max loss is appropriate to your average winners is the first thing to check.

If the max loss is appropriate and you find that you still are breaching it on a regular basis, the next thing to seriously consider is your position sizing. If you are hitting the 5% max loss on one trade, your size is too big. Scaling down and being able to take more trades will help smooth out the trading dataset you are building. Think about the law of large numbers.

Lastly, if you are hitting the max loss more than once a week, you need to reconsider your overall trading strategy. Do you have a strategy that is adaptable for different market environments? Does your strategy make logical sense? Does your strategy have a set of rules that validate an entry? Max loss multiple times a week would imply that the underlying strategy and risk management tactics are illogical.

Conclusion

Implementing a day trading daily loss limit is vital to protecting your trading account. Whether you are a new trader or an experienced one with a track record, establishing a predetermined maximum loss for each trading day will prevent account blow up. Remember, the ultimate goal is to build a sustainable trading career that thrives over a long time horizon, not produces overnight riches.