Fundamental Rule of Day Trading: Preservation of Capital

I don’t necessarily encourage anyone to day trade, but anyone who will consider should remember the first law of making money: preserve your capital. Some day traders will go as far as to say that is all they do.

Here are my rules of day trading:

1. Have a good direct access broker with good execution and good fees.
2. Preserve capital:
   1. Sell for small losses.
   2. Sell for small gains.
   3. Sell for large gains.
   4. Never sell for large losses.

Quite simple isn’t it? Last week I ignored #1 and #4. The result was instead of being up $3500 for the month, I ended up only up $500. My black Thursday was not a bad market. It was my rule-breaking. I could have sold on Wed for a small loss. Instead I held on due to emotions and ended up with a large loss that wiped up much of my hard work.

The Disciplined Day Trader

Here’s how the disciplined trader makes money consistently. The below picture says it all. You can lose on 70% of your trades and still make money. You must exit your losers early and keep the winners until their run-up is done. This is how you make money day-trading. This is how I make money day-trading. When I ignore this, I lose money.

2 small wins, 1 big win, and 7 small losses = $50 profit

The “Hopeful” Day Trader

Day-traders that lose money and ultimately stop day-trading more often than not follow the below pattern. They hold on to their losers too long hoping for them to become positive. This emotional attachment is the kryptonite of day-traders. It kills a portfolio and ultimately leads to losses on a consistent basis.

Look at the below depiction. The above diagram can just as easily be the below for a hopeful day-trader.

The day trader has essentially the same holding as before. The only difference is instead of taking 2 small losses, he chose to let them grow into large losses. (incidentally this is the exact scenario that played out in my lapse of discipline on Wednesday).

Lesson

Have Discipline and make money.