Updated: Aug 6
You take for each trade the risk to loss money, that´s why it is mandatory to handle each trade with a good risk/reward distribution.
Your distribution should be a minimum of 1:2 ratio.
Successful day traders are generally aware of both the potential risk and potential reward before entering a trade.
The goal of a day trader is to place trades where the potential reward outweighs the potential risk. These trades would be considered to have a good risk/reward ratio.
A risk/reward ratio is simply the amount of money you plan to risk compared to the amount of money you plan believe you can gain.
For example, if you think a potential trade may result in either a $400 profit or $100 loss, the trade would have a risk/reward ratio of 1:4, making it a favorable setup. Contrarily, if you risk $100 to make $100, the trade has a risk/reward ratio of 1:1, giving you the same type of unfavorable odds that you can find in a casino.
With regards to the long-term profitability formula above, finding trades with high risk/reward ratios (1:2 or higher), will help you maintain higher average profits and lower average losses, making your trading strategy more sustainable.
A stop-loss is a pre-planned exit order for a losing trade. These can be executed manually or automatically on your broker platform.
The purpose is to cut losses before they grow too large. Stopping out of a losing trade can be one of the hardest things for day traders to do consistently. However, failing to take stops can result in margin calls, unnecessarily large losses, and ultimately account blowouts.