Day trading is a process in which a person allocates money to financial assets such as stocks, cryptocurrencies, commodities, bonds, and exchange-traded funds (ETFs) in order to short term gains.
The goal of any day trader is for all trades to be profitable. However, in most cases, some of these trades are usually not profitable. In this article we will look at the concept of cutting losses and how to do it well.
What does cut losses mean?
As a day trader, your goal is to ensure that your trades are profitable. However, in most periods, this is not usually the case. historically, Most traders tend to open losing trades. So, Cut losses A process in which a trader or investor decides Close a deal in the red.
For example, in the chart below, we see that Nvidia shares have been rising for months. Suppose you believe a stock is overvalued and then decide to short at $289. In this case, your goal is Tap with the arrow down.
However, as you can see, The stock jumped sharply after The company announced strong financial results. The stock has gone from $300 to about $390.
In this case, you can decide to continue to hold the short position or cover it. If you decide to close a short position, it means that you have just decided to cut your losses.
The benefit of cutting losses is that it helps Reducing the possibility of a trader losing a lot of money.
In the example above, a trader who took a short trade at $290 and cut losses at $310 would have saved a lot of money since the stock went up to almost $400.
Reasons to cut your losses
There are several reasons why you might want to cut your losses when day trading:
When there is new information
In most periods, it is usually there Reason when entering into a deal. For example, you might buy a stock in the expectation that it will post strong financial results. In other periods, you might enter into a trade with the hope that a new product will do well in the market.
Related “ Explanation of buying and selling points
In some cases, a The market will not always live up to your expectations. For example, a a company Can Posting worse results than you’d expectwhich sent stocks lower.
In this period, this means that you will do much better by cutting your losses as soon as possible to prevent further losses.
When an art pattern is invalidated
daily traders Reliance on technical patterns to make decisions. These patterns are divided into reversals and continuations. Examples of popular patterns to use in day trading are:
- The double top
- Double bottom
- Head and shoulders
- Cup and handle
- The rising and falling wedges
In some cases, you may open a trade because of a patternwho is next Revoke soon. For example, in the chart below, we see that AMD stock formed a double top pattern at $102.11.
In price action analysis, this pattern is usually a bearish signal. However, as we can see below, the stocks made an upward breach above the double top level.
Therfore, as a responsible trader, the wise thing would have been to exit the trade and cut your losses since the breakout occurred, and the shares brought in the next point of resistance at $164.32.
Towards the end of the trading day
Another reason why you might want to cut your losses is Towards the end of the trading day. An important rule of thumb as a day trader is to make sure of this all your deals We are closed when the market closes.
In this case, if the transaction is in a losing category, it is recommended to just close it. The risk of taking a trade overnight is that there could be a large gap when the market opens the next day.
Why do traders avoid cutting losses?
Cutting losses is never fun. In fact, historically, we’ve seen many well-known investors do just that.
For example, Bill Ackman had to take a big loss a few years ago by closing his business in Valeant Pharmaceuticals. There are still many reasons why traders avoid cutting losses.
Hoping for a turnaround
The most important reason most traders avoid cutting losses is that they are Hopes that the original will have turn around almost.
For example, if you have a long stock that is going down, you might hope that it will change direction. While this can happen at certain times, the losses can continue to mount.
Another important reason why you should avoid cutting losses is that you are overconfident about the trade.
For example, you might buy a stock because you strongly believe it will continue to rise. If things change, you may still be very confident about it.
Strategies to help you avoid cutting losses
There are many strategies that will Help you avoid reducing losses. First, always use a stop loss or take profit order when day trading.
Stop loss recommendation Stop your trade automatically When it reaches a certain level of loss while Take Profit stops it when it reaches the level of profit. You should always set the two when opening the trade.
Secondly, always Stay informed by accessing the latest news around an asset. For example, when you have a long stock like Apple, new information can come up. As a result, you should always be aware of what is going on.
Third, always embrace good position sizing to ensure no further losses per trade. In line with this, make sure to use moderate leverage in all of your trades.
In this article, we have looked at the concept of cutting your losses when day trading. While it is always difficult to cut losses, doing so early enough will help you avoid further losses.
We’ve also looked at some of the best strategies to use when cutting losses and evaluated some of the main reasons why you should consider cutting losses.
Useful external sources
- Still Rule #1 for stock market investors: Always cut your short losses – Investors