Much of this book is designed to give you ideas about whether to day trade at all, what you want to trade, and how you want to trade it. That leaves one remaining issue: how much of your money to put on the line each time you trade. Risk too much, and you can be put out of business when you lose your capital. Risk too little, and you can be put of out business because you can’t make enough money to cover your costs and time.

Over time, many academic theorists and experienced traders have developed different systems of money management designed to help traders, investors, and even gamblers manage their money in order to maximize return while protecting capital. In this chapter, I explain how some of the better-known systems work so that you can figure out how to best apply them to your own trading.

Some of the material is related to leverage, which is borrowing money to trade. Leverage can dramatically increase the money that you have available to trade as well as the risk and return profile of the trades that you make, so it affects how you manage your money.

What’s Your Expected Return?

Before you can figure out how to manage your money, you need to figure out how much money you can expect to make. This is your expected return, although some traders prefer the word expectancy. You start by laying out your trading system and testing it. You are looking for four numbers:
  • How many of your trades are losers?
  • What’s the typical percentage loss on a losing trade?
  • How many of your trades are winners?
  • What’s the typical percentage gain on a winning trade?

Let’s say you determine that 40 percent of the time a trade loses, and it loses 1 percent. Sixty percent of the time, the trade wins, and winning trades are up 1.5 percent. With these numbers, you can calculate your per-trade expected return, like this:

   % of losing trades × loss on losing trades + % of winning trades × gain on winning trades = expected return

Which in this example, works out to be:

   .40 × –.01 + .60 × .015 = –.004 + .009 = .005

On average, then, you would expect to earn a half a percent on every trade you make. Make enough trades with enough money, and it adds up.

You are more likely to make more money if you have a high expectation of winning trades and if those winners are expected to perform well. As long as there is some probability of loss, you stand to lose money.

The Probability of Ruin

Expected return is the happy number. It’s how much money you can expect to make if you stay in the trading game. But it has a counterpart that is not so happy but is at least as important: the probability of ruin.

As long as there is some probability of loss, no matter how small, there is some probability that you can lose everything when you are trading. How much you can lose depends on how large each trade is relative to your account, the likelihood of each trade having a loss, and the size of the losses as they occur.

Shows the math for finding R, the probability of ruin.

A is the advantage on each trade. That’s the difference between the percentage of winning trades and the percentage of losing trades. In the expected return example discussed earlier, trades win 60 percent of the time and lose 40 percent of the time. In that case, the trader’s advantage would be:

   60% – 40% = 20%

C is the number of trades in an account. Let’s assume that we’re dividing the account into ten equal parts, with the plan of making ten trades today. The probability of ruin today is 1.7 percent.

Now, 1.7 percent isn’t a high likelihood of ruin, but it’s not zero, either. It could happen. If your advantage is smaller, if the expected loss is larger, or if the number of trades is fewer, then the likelihood becomes even higher. 

Shows you the relationship between the trader’s advantage, number of trades, and the corresponding probability of ruin, rounded to the nearest percentage.

The bigger the edge and the more trades you can make, the lower your probability of ruin. Now, this model is a simplification in that it assumes that a losing trade goes to zero, and that’s not always the case. In fact, if you use stops, you should never have a trade go to zero. But you can see steady erosion in your account that will make it harder for you to make money. Hence, probability of ruin is a useful calculation that shows whether you will lose money in the long run.

The more trades you can make with your account, the lower your probability of ruin. That’s why money management is a key part of risk management.

Why Size Matters

As long as there is some chance of losing all your money, you want to avoid betting all of it on any one trade. But as long as there is a chance of making money, you want to have enough exposure to a winning trade so that you can post good profits.

Later, I describe some of the different money management systems that traders use to out how much money to risk per trade. But first, I want to explain the logic behind a money management system, so that you understand why you need one. That way, you can better manage your funds and improve the dollar returns to your trading.

Valuing volatility

Expected return gives you an idea of how much you can get from a trade on average, but it doesn’t tell you how much that return might vary from trade to trade. The average of 9, 10, and 11 is 10; the average of –100, 10, and 100 is also 10. The first number series is a lot narrower than the second. The wider the range of returns that a strategy has, the more volatile it is.

There are several ways to measure volatility. One common one is standard deviation, which tells you how much your actual return is likely to differ from what you expect to get. The higher the standard deviation, the more volatile, and riskier, the strategy.

In the derivatives markets, volatility is measured by a group of numbers known as the Greeks: delta, gamma, vega, and theta. They’re based on calculus.

  • Delta is a ratio that tells you how much the option or future changes in price when the underlying security or market index changes in price. Delta changes over time.
  • Gamma is the rate of change on delta. That’s because a derivative’s delta will be higher when it is close to the expiration date, for example, then when the expiration date is further away.
  • Vega is the amount that the derivative would change in price if the underlying security became 1 percent more volatile.
  • Theta is the amount that a derivative’s price declines as it gets closer to the day of expiration.
Day traders seek out more volatile securities, because they offer more opportunities to make money during any given day. That means they have to have ways to minimize the damage that might occur while being able to capitalize on the upward swings. Money management can help with that.

Staying in the market

You only have a limited amount of money to trade. Whether it’s $1,000 or $1,000,000, once it’s gone, you’re out. The problem is that you can have a long string of losing trades before the markets go in a direction that favors you and your system.

Let’s say you trade 100 percent of your account. If you have one trade that goes down 100 percent, then you have nothing. If you divide your account into ten parts, then you can have ten total losers before you are out. If you start with ten equal parts and double each time you lose, you can be out after four losing trades.

The riskier your trading strategy, the more thought you need to put into money management. Otherwise, you can find yourself out of the market in no time.

On the other hand, if you divide your account into 100 portions, then you can endure 100 losing trades. If you trade fractions of your account, then you can keep going infinitely, or at least until you get down to a level that’s too low to place a minimum order. Money management can keep you in the game longer, and that will give you more opportunities to place winning trades.

Considering opportunity costs

Opportunity cost is the value you give up because you choose to do something else. In trading, each dollar you commit to one trade is a dollar that you cannot commit to another trade. Thus, each dollar you trade carries some opportunity cost, and good traders seek to minimize this cost. During the course of the trading day, you may see several great trades, and some opportunities will show up before you are ready to close out a different trade.

If you have committed all your capital to one trade, you will miss out on the second. That alone is a good reason to keep some money on the table each time you trade.

Money Management Styles

Over the years, traders have developed many different ways to manage their money. Some of these are rooted in superstition, but most are based on different statistical probability theories. The underlying idea is that you should never place all of your money in a single trade, but rather put in an amount that is appropriate given the level of volatility. Otherwise, you risk losing everything too soon.

Calculating position size under many of these formulas is tricky stuff. That’s why brokerage firms and trading software packages often include money management calculators.

This is only a sample of some methods. There are other methods out there, and none is suitable to all markets all the time. Folks trading both options and stocks may want to use one system for option trades and another for stock trades. If that’s your situation, you have one big money management decision to make before you begin: how much money to allocate to each market.

Fixed fractional

Fixed fractional trading assumes that you want to limit each trade to a set portion of your total account, often between 2 and 10 percent. Within that range, you’d trade a larger percentage of money in less risky trades and at the smaller end of the scale for more risky trades.

Show the fixed fractional equation.

N is the number of contracts or shares of stock you should trade, f is the fixed fraction of your account that you have decided to trade, equity is the value of your total account, and trade risk is the amount of money you could lose on the transaction. Because trade risk is a negative number, you need to convert it to a positive number to make the equation work. Those vertical bars in the equation (||) are the sign for absolute value, and that means that you convert the number between them to a positive number.

This means that if you have decided to limit each trade to 10 percent of your account, if you have a $20,000 account, and if the risk of loss is –$3,500.

Of course, you probably can’t trade .57 of a contract, so in this case, you would have to round up to one.

Fixed ratio

The fixed ratio money management system is used in trading options and futures. It was developed by a trader named Ryan Jones, who wrote a book about it. In order to find the optimal number of options or futures contracts to trade, N.

N is the number of contracts or shares of stock that you should trade, P is your accumulated profit to date, and the triangle, delta, is the dollar amount that you would need before you could trade a second contract or another lot of stock.

For example, the minimum margin for Chicago Mercantile Exchange E-Mini S&P 500 futures contract, which gives you exposure to the Standard & Poor’s 500 stock index, is $3,500. Until you have another $3,500 in your account, you can’t trade a second contract. If you are using fixed ratio money management to trade this future, your delta will be $3,500.

If your delta is $3,500, and you have $10,000 in account profits, you should trade 1.2 contracts. In reality, that means you can only trade one contract or two contracts, nothing in between. That’s one of the imperfections of most money management systems.

The idea behind fixed ratio trading is to help you increase your exposure to the market while protecting your accumulated profits.


William Gann developed a complicated system for identifying securities trades. Part of that was a list of rules for managing money, and many traders follow that if nothing else.

The primary rule is: Divide your money into ten equal parts, and never place more than one 10-percent portion on a single trade. That helps control your risk, whether or not you use Gann.

Kelly Criterion

The Kelly Criterion emerged from statistical work done at Bell Laboratories in the 1950s. The goal was to figure out the best ways to manage signal-noise issues in long-distance telephone communications. Very quickly, the mathematicians who worked on it saw that there were applications to gambling, and in no time, the formula took off.

To calculate the ideal percentage of your portfolio to put at risk, you need to know what percentage of your trades are expected to win as well as the return from a winning trade and the ratio performance of winning trades to losing trades. The shorthand that many traders use for the Kelly Criterion is edge divided by odds, and in practice, the formula looks like this:

   Kelly % = W – [(1 – W) / R]

W is the percentage of winning trades, and R is the ratio of the average gain of the winning trades relative to the average loss of the losing trades.

I had an example of a system that loses 40 percent of the time with a loss of 1 percent and that wins 60 percent of the time with a gain of 1.5 percent. Plugging that into the Kelly formula, the right percentage to trade is .60 – [(1-.60)/(.015/.01)], or 33.3 percent.

As long as you limit your trades to no more than 33% of your capital, you should never run out of money. The problem, of course, is that if you have a long string of losses, you could find yourself with too little money to execute a trade. Many traders use a “half-Kelly” strategy, limiting each trade to half the amount indicated by the Kelly Criterion, as a way to keep the trading account from shrinking too quickly. They are especially likely to do this if the Kelly Criterion generates a number greater than about 20 percent, as in this example.


The martingale style of money management is common with serious casino gamblers, and many traders apply it as well. It’s designed to improve the amount of money you can earn in a game that has even odds. Most casino odds favor the house (roulette wheels used to be evenly black and red, but casinos found that they could make more money if they inserted a green slice for zero, thus throwing off the odds). Day trading, on the other hand, is a zero sum game, especially in the options and futures markets. This means that for every winner, there is a loser, so the odds of any one trade being successful are even. The martingale system is designed to work in any market where the odds are even or in your favor.

Under the martingale strategy, you start with a set amount per trade, say $2,000. If your trade succeeds, you trade another $2,000. If your trade loses, you double your next order so that you can win back your loss.

Under the martingale system, you will always come out ahead as long as you have an infinite amount of money to trade. The problem is that you can run out of money before you have a trade that works. The market, on the other hand, has almost infinite resources because of the huge volume of participants coming and going all over the world. That means that you have an enormous disadvantage. As long as you have a disadvantage, thoughtful money management is critical.

Monte Carlo simulation

If you have the programming expertise or buy the right software, you can run what’s called a Monte Carlo simulation. In this, you enter in your risk and return parameters and your account value, let the program run, and it returns the optimal trade size. The system is not perfect — it is only a model that can’t incorporate every market situation that you’ll face and it has the fractional trade problem that the other systems do. But it has one big advantage: It can incorporate random changes in the markets in ways that simpler money management models cannot.

Monte Carlo simulation is not a do-it-yourself project, unless you have extensive experience creating these programs. If you are interested, you need to find a suitable program.

Optimal F

The Optimal F system of money management was devised by Ralph Vince, and he’s written several books about this and other money management issues. The idea is that you determine the ideal fraction of your money to allocate per trade based on past performance.

If your Optimal F is 18 percent, then each trade should be 18 percent of your account — no more, no less. The system is similar to the fixed fraction and fixed ratio methods discussed earlier, but with a few differences.

Shows the equation for finding the number of shares of stock, N, to trade.

F is a factor based on the basis of historical data, and the risk is the biggest percentage loss that you experienced in the past. Using these numbers and the current price, you can find the contracts or shares you need to buy. If your account has $25,000, your biggest loss was 40 percent, your F is determined to be 30 percent, and you’re looking at a stock trading at $25 per share, then you should buy 750 shares.

The Optimal F number itself is a mean based on historical trade results. The risk number is also based on past returns, and that’s one problem with this method: it only kicks in after you have some trade data. A second problem is that you need to set up a spreadsheet to calculate it. Some traders only use Optimal F in certain market conditions, in part because the history changes each time a trade is made, and that history doesn’t always lead to usable numbers.

How Money Management Affects Your Return

It’s one thing to describe why you need money management, but it’s more fun to show you how it works. And because I love making spreadsheets, I pulled one together to show you how different ways of managing your money might affect your return.

I started with the expected return assumptions that I used in the earlier example: 40 percent of the time a trade loses, and it loses 1 percent. 60 percent of the time, the trade wins, and winning trades are up 1.5 percent. I pick a hypothetical account of $20,000 and set up mock trades using these expected return numbers. Compares the performance of martingale and Kelly money management to betting the whole account each time.

You may notice that you end up with the most money from trading the entire account. That doesn’t mean you always get the most money this way, just that that’s how the numbers worked out in this case, given the 60/40 win ratio and a 3/2 winning size/losing size ratio. 

This is just an example, applying some different strategies to different hypothetical returns. I’m not recommending any one system over another. The best system for you depends on what assets you are trading, your personal trading style, and how much money you have to trade.

Planning for Your Profits

In addition to determining how much to trade each time you place an order, you need a plan for what to do with the profits that accumulate in your account. That’s as much a part of money management as calculating your probability of ruin and determining trade size.

Are you going to add the money to your account and trade it as before? Leverage your profits by trading them more aggressively than your core account? Pull money out and put it into long-term investments? Or a combination of the three?

Compounding interest

Compound interest is a simple concept: Every time you get a return, that return goes into your account. You keep earning a return on it, which increases your account size some more. You keep earning a return on your return, and pretty soon, the numbers get to be pretty big.

In order to benefit from that compounding, many traders add their profits back into their accounts and keep trading them, in order to build account size. Although day traders earn little to no interest, the basic principle holds: By returning profits to the trading account to generate even more profits, the account should grow over time.

This practice of keeping profits in the account to trade makes a lot of sense for smaller traders who want to build their accounts and take more significant positions over time.

Pyramiding power

Pyramiding involves taking trading profits and borrowing heavily against them to generate even more profits. Traders usually do this during the day, using unrealized profits in trades that are not yet closed as collateral for loans used to establish new positions. If the new positions are profitable, the trader can keep borrowing until it’s time to close everything at the end of the day.

This works great as long as the markets are moving in the right direction. If all the positions in the pyramid remain profitable, you can make a lot of money during the course of the day. But if one of those positions turns against you, the structure collapses and you end up with a call on your margin. Starts with an initial trade of $2,000 and assumes a return of 10 percent on each transaction — not realistic, necessarily, but it makes for a nice chart.

If the profits from each trade are used as collateral for borrowing, and if that 10 percent return holds all day, then the trader can make 17 percent by pyramiding those gains. If a reversal hits before the end of the trading session and the positions lose 10 percent, then pyramiding magnifies the losses — assuming your broker would let you keep borrowing. After all, the borrowed money has to be repaid regardless of what happens in the market.

Pyramiding is not related to a pyramid scheme. In trading terms, pyramiding is a way to borrow against your profits to generate even bigger profits. A pyramid scheme is a fraud that requires participants to recruit new members, and fees paid by the new members go to the older ones. Eventually, the pyramid collapses because it gets too difficult to recruit new members, and those at the bottom get nothing.

Some investment frauds have been structured as pyramid schemes, so bewary of deals that sound fabulous and also require you to recruit others.

Pyramiding increases your trading risk, but also your expected return. It’s a useful way to grow a portion of your trading account, especially when the market is favoring your trading system. It’s a good technique for a medium-sized account that would have enough money left over to stay in the market if a pyramid were to collapse on you.

Regular withdrawals

Because day trading can be so risky, many traders look to diversify their total financial risk. One way to do this is to pull money out of the trading account to put into a less volatile long-term investment. Many traders routinely pull out a percentage of their profits and put that money into government bonds, a low-risk mutual fund, or real estate. None of these investments is as glamorous or exciting as day trading, but that’s the point:

Trading is hard work, and anyone can lose money any day, no matter how big their account is or how much money they have made so far. By moving some money out, a trader can build a cushion for a bad trading stretch, prepare for retirement, and have some money to walk away for a short period or even forever. That can greatly reduce the stress and the fear that go with trading.

The larger the account, the easier it is to pull money out, but even smaller traders should consider taking 5 or 10 percent of each quarter’s profits and moving them into another type of investment. Many brokerage firms can set up automatic withdrawal plans that zap money from your trading account to a stock or bond mutual fund, if you don’t trust yourself to do it.




Day trading can be a ruthless business. Some days, you don’t find any trades worth making. Other days, you find trades, but they don’t work out the way you want them to. And some days, there are too many good trades, more than you can possibly make, and so you watch profitable opportunities slip away. When you’re working with real money, it can be too much to take.

In a money management or brokerage firm, traders have tremendous camaraderie. They are working for the same employer and need to stick together to blow off the stress. What do you do at home, though? How do you keep from panicking, getting depressed, or otherwise letting this business hurt your profits and hurt you?

If you’re going to day trade, you need to understand the very real physical and psychological stresses that the market pushes on its participants. In this chapter, I offer some information and advice that can help you avoid a crisis.

First, the Cautionary Tales

Trader lore is loaded with stories of people who flamed out in spectacular and destructive ways. People who work on trading desks or on trading floors tell tales of colleagues who went down, walked off the desk, broke down in the pit, or died at the trading post. They can tick off colleagues who are alcoholics, who suffered bitter divorces, who committed suicide. Even though day traders usually work by themselves, stories of their self-destructive behavior abound.

Sure, many day traders lead pleasant lives and suffer no more problems than any other person. That’s because they have perspective, balance, and the right personality for the business. Know what can go wrong, because it can help you keep in the right.

Jesse Livermore

Jesse Livermore is sometimes considered to be the father of day trading. He’s the subject of the book Reminiscences of a Stock Operator by Edwin LeFevre, a classic book about trading. Livermore was born in 1877 and started trading stocks when he was in his teens. He claimed to have made $1,000 when he was 15, which may not seem like much, except that he was very young and price levels were a little different in 1892. He made huge fortunes betting against the market in 1907 and again in 1929, and he managed to lose it all both times. By 1934 he was broke and depressed. He attempted suicide in 1935 and succeeded in 1940.

Mark Barton

Mark Barton lost $105,000 day trading and he snapped. On July 27, 1999, he bludgeoned his wife and two children to death. Then he went to the downtown Atlanta offices of Momentum Securities, a brokerage firm that specialized in working with day traders. He had an appointment to deliver $50,000 so that he could cover his losses and start trading again. Instead, he took out a gun, opened fire, and killed four people. He then went to the offices of All Tech Investment Group, another day trading firm where he had an account, and killed another five people. Barton killed himself before he was arrested. This case is one of the worst workplace massacres in the United States, and it did as much as the 2000 meltdown in NASDAQ technology stocks to reduce the enthusiasm for day trading.

Anecdotal suicides, divorces, alcoholism

Because not that many people day trade consistently, not a lot of good demographic studies have been conducted on just how many day traders end up abusing drugs and alcohol, getting divorced or becoming estranged from friends, and turning to suicide. The anecdotal evidence is pretty strong, though. People in the securities business face high pressure and real dollar losses every day they go to work.

Their performance is constantly judged by the market, and it doesn’t grade on a curve. If you spend even a few minutes talking to people in the business, you hear horror stories. I personally know a trader who set fire to his house, killing his 90-year-old mother in the process, to get the insurance proceeds to cover his financial shortfalls.

Don’t be the person who finally gives researchers enough critical mass to report on day trader self-destruction. Stress is a real part of day trading, and not all day traders handle it well. If you know what you’re up against and prepare for it, you’ll be better off than many.

Controlling Your Emotions

The key to successful day trading is controlling your emotions. After all, the stock doesn’t know that you own it, as equity traders like to say, so it isn’t going to perform well just because you want it to. This can be infuriating, especially when you are going through a draw-down of your capital. Those losses look mighty personal.

Traditional financial theory is based on the idea that traders are rational. In practice, however, most of them are not. In fact, traders and investors are often irrational in completely predictable ways, which has given birth to a new area of study called behavioral finance. It’s a hot area generating Nobel Prize winners, and it may eventually help people incorporate measures of investor behavior into buy and sell decisions.

You have to figure out a way to manage your reactions to the market, or you shouldn’t be a day trader. Almost to a one, day traders talk about their enemies being fear and greed. If you panic, you’ll no longer be trading to win, but trading not to lose. There’s an important distinction: If your goal is not to lose, you won’t take appropriate risk, and you won’t be able to respond quickly to what the market is telling you.

This is all much easier said than done. Human beings are emotional creatures, constantly reacting to everything that is happening in their lives. Knowing the emotions that affect trading and having some ways to manage them can greatly improve your overall performance.

The big five emotions

When it comes to trading, five big emotions can take over and mess up your strategy and your returns. At this point in your life, you may already know whether you have tendencies toward some of them. If so, trading can exacerbate them. If you’ve never experienced them, you might for the first time. Here’s a list and some descriptions so that you know what you’re up against and can plan accordingly. I include some tips that can help, but if you are really in the throes of an emotional crisis that affects your trading, you should seek out professional help.


Anxiety is the anticipation of things going wrong, and it often includes a physical response: perspiration, clenched jaws, tense muscles, heart palpitations. Anxious people worry, agonize, overanalyze, and generally stress out. And then they avoid whatever it is that makes them upset. That means that a trader might not make an obvious trade, but instead hesitate and miss a market move. He might hold on to a losing position too long because he’s worried about the effect that selling it will have on his portfolio. He becomes too nervous to trade according to his plan, and his performance suffers.

One way to fight trading anxiety is to concentrate on following the trading plan, not on making a set amount of money. That way, following the plan becomes more automatic, and you spend less time worrying about what can go wrong.


Here’s the ugly truth about day trading: It can be really dull. In an eight-hour trading session, you might spend seven and a half hours waiting for the right opening. A flurry of trades, and it’s all over. To keep yourself entertained, you might start making bad trades, spending too much time in chat rooms, or letting your mind wander away from the task at hand. None of those things is conducive to profitable trading.

If you are really bored and tempted to do something stupid, close out your positions and take a break. Going for a walk or quitting early can clear your head and help you focus when you get back. Remember, day traders work for themselves, and one of the benefits of that is that there is no boss to find out that you knocked off early. Take advantage of that!


Depression is a severe downturn in your mood, especially one that causes you to feel inadequate and lose interest in things you used to like. Although everyone is susceptible to depression, the ups and downs of the market can make traders particularly vulnerable. At best, depression can make it hard for a trader to face a day with the market. At worst, it can lead to alcoholism, alienation, and even suicide.


Fear is one of the worst emotional enemies of the day trader. Instead of trying to make money, the fearful trader is trying hard not to lose it. She is so afraid of failing that she limits herself, doesn’t take appropriate risk, and questions her trading system so much that she no longer follows it, no matter how well it worked for her in the past.

By the way, it isn’t just failure that traders fear. Many fear success, sometimes for deep-seated psychological reasons that I am in no position to address. A trader who fears success may think that if she succeeds, her friends will treat her differently, her relatives will try to take her money, and that she will become someone she doesn’t want to be.

One way to limit fear is to have a plan for the trading business. Before you start trading, take some time — maybe half a day — to sit down and think about what you want, what will happen to you if you get it, and what will happen to you if you don’t. For example, if you lose your trading capital, then you’ll have to live on your walk-away fund until you find another job. If you make a lot of money, then you can pay off your mortgage and your friends will be none the wiser.


Greed seems like a silly thing to have on this list. After all, isn’t the whole purpose of day trading to make money? This isn’t charity, this is capitalism at its purest. Ah, but there’s a popular saying down at the Chicago Board of Trade:

   “Pigs get fat, but hogs get slaughtered.”

Traders who get greedy start to do stupid things. They don’t think through what they are doing and stop following their trading plans. They hold positions too long in the hope of eking out a return and sometimes they make rash trades that look an awful lot like gambling. The greedy trader loses all discipline and eventually loses quite a bit of money.

If your goal is simply to make more and more money, you might have a problem with greed. Sure, everyone wants to make more, but there are also a basic need-to-make number and a want-to-make number. If you know what those numbers are, you’re well on your way to preventing the problem.

Limit orders, which automatically close out positions when they hit set prices, are one way to force discipline in the face of greed.

Having an outlet

Successful day traders have a life outside of the markets. They close out their positions, shut off their monitors, and go do something else with the rest of the day. That’s the whole idea behind day trading.

The problem is that there is always a market open somewhere. Traders work overnight and after hours through electronic communications networks and sometimes move the action to exchanges in other parts of the world. Without something to mark a beginning and an end to your trading day, and without other things happening in your life, the market can consume you in a way that’s simply not healthy.

So as you plan your life as a day trader, think about what else you’re going to do with your days. Exercise, meditation, socializing, and having outside interests are key to maintaining balance and staying focused on the market when you have to be.


Exercise keeps your body in fighting shape so that you can stand up to market stress and react to trends when you need to. Many times when you’re trading, you have huge rushes of adrenalin that you can’t do much about. You have to stay in front of your screen until the trade is over, no matter how much you want to run away screaming. But after the trading day, you can hit the track or pool or treadmill and burn off some of that adrenalin. Figuring out a regular exercise routine can pay off for your trading.

If you aren’t an exerciser now, call your local YMCA. They have introductory programs that can teach you how to use the equipment and help you design a workout that suits your current fitness levels and goals.


You may have closed out your positions and shut down your monitors, but the day’s trading may keep playing itself out over and over in your head. When you are trading, you may get upset and start thinking about everything else that has ever gone wrong in your life, instead of staying focused on the task at hand. Trading, therefore, requires mental discipline. Good traders can keep their minds clear of everything but their trading system, at least when the markets are at their hairiest.

One way to develop that discipline is to take up meditation. Yeah, it may seem goofy, being a big tough trader type doing something woo-woo like meditation, but if you have trouble keeping your focus, you really might want to take it up. There are an almost infinite number of meditation styles, many of which are associated with different religious traditions, so you can surely find something that works.

Friends and family

Day trading is a lonely activity. You’re working by yourself all day. It’s just you, your room, and your screen. It’s really isolating, and if you don’t get other human contact, you’ll personalize the market so that you don’t feel so lonely. That’s bad, because the market isn’t a person; it’s an agglomeration of all the financial activity taking place, and it has no interest in you whatsoever.

No matter what you do in life, you want to have the support of the people you know and love. And you need to make time for them, too. Start and end your trading day at regular times, and be sure to make plans to see people who are important to you. Going to your kid’s ball game, having dinner with your spouse, and seeing your buddies for a few beers on a regular basis can go a long way to keeping your life in balance — and that will keep your trading in balance.

Hobbies and other interests

A lot of people get into day trading because they have long had a fascination with the market. Trading goes from being a hobby to being a living. In many ways, that’s perfect. It’s so much easier to go to work if you have a job that you love.

But if the market is your only interest, then you’re going to be too susceptible to its gyrations and you’re going to have trouble sticking to your trading discipline. Plus, whatever upsets you during the trading day is more likely to carry over. So find a new hobby if you don’t have one. Maybe it’s a TV show, a sport, or knitting, but whatever it is, you need to have something going on outside of your trading.

Trading is just one part of your life.

Support systems

Exercise and friends and family and hobbies and the like are all well and good, but they don’t directly address the mindset of trading. Ah, but there’s a veritable industry of support for traders, and it’s easy to tap into. Many day traders find that reading books, hiring a coach, or finding other day traders helps them get through the day.


A library-full of books have been written on the psychology of trading itself. In addition, many traders rely on other self-help and history books for inspiration and ideas. (I think every trader I’ve ever known owns a copy of Sun Tzu’s The Art of War, which is about military strategies and tactics. They find that it helps them prepare their minds to face the market, or at least gives them something interesting to talk about.) I list several books in the Appendix that might help you organize your mind and keep your enthusiasm for the market.

Counseling and coaching

Because it takes a lot of mental toughness to handle big losses — and big gains — many traders find professional support. They use counselors, psychologists, or life coaches to help them deal with the challenges of the market and understand their reactions to it. You can ask other traders or your doctor for a referral, or check the online directory at Psychology Today’s Web site or the International Coach Federation. When interviewing coaches or counselors, ask whether they have experience with traders or others who work in finance.

Many day trading training and brokerage firms also offer coaching services that specialize in helping people learn and follow day trading strategies. Some day traders find these people to be invaluable, whereas others find they are just glorified salespeople.

Some day trading coaches may be more interested in selling you specific trading strategies rather than helping you manage your own system. Check references and find out what other forms of compensation the coach receives before signing up.

Finding other traders

To offset the loneliness of trading alone, many day traders choose to work out of trading rooms operated by brokerage firms or join organizations where they will meet other traders. These may be formal or informal groups where traders can socialize, learn new things, or just commiserate.

Many day traders get together through Internet message boards and chat rooms. These groups are less formal, more anonymous, and sometimes more destructive than supportive. Most day traders lose money and give up their first year. You may find that spending too much time with other traders is more depressing than supportive.

Watching your walk-away money

A lot of traders have a secret that lets them get through the worst of the markets. It’s something called walk-away money, although traders sometimes use more colorful language to describe it. It’s enough money that they can walk away from trading and do something else.

And just exactly how much is it? Well, it varies from person to person, but having enough money to pay three months’ worth of expenses on hand and in cash is a good place to start. If you know that you can pay the mortgage and buy the groceries even if you don’t make money trading today, you’ll be better able to avoid desperate trading. You won’t have to be greedy, and you won’t have to live in fear.

The more money in your walk-away fund, the better. Then you have more time to investigate alternative careers should day trading prove not to be your thing, and you can relax more when you face the market every day.

Most day traders quit after a year or so. There’s nothing wrong with deciding to move on and try something else. If you have some money saved, then you’re in a better position to control when you stop trading and what you do next.

If all your trading capital is gone, you might be tempted to tap your walkaway fund to stay in the game. Don’t. That’s the exactly the time that you should use your walk-away money to walk away, if only for a short time to clear your head and rethink your strategies. Otherwise, your trading losses may become financial ruin.

Importance of a Trading Plan

You may have noticed that trading plans pop up several times. That’s because they are so important to maintaining the discipline that leads to trading success. You have to know what you’re doing and how to recognize entry and exit points and then go and do it.

In this section, I cover how you can use a trading plan to manage stress and give you a few tips for sticking to your trading plan even as the markets sometimes move against you.

Problems following direction

Was that written on all your report cards? I hope not. A good, tested trading plan sets out market patterns that work often enough that you can make good trading profits. But some people have trouble following their plan, and that leads to stressful mistakes.

Prevent choking!

In sports lingo, an athlete who chokes starts playing so carefully that he or she looks like a beginner. This is often caused by over-thinking — by being so afraid of failure that the mind slows down and breaks the play down step by step. It’s not pretty to watch a contender break down in a championship game. The fans want to see a good match.

Anyone in a high-performance situation can choke. When a trader chokes, he seems to be following the plan, but it’s no longer automatic. Trading becomes so slow and deliberative that obvious trades get missed.

The more you trust your plan, the less likely you are to choke. Has it been tested? Are there parts that you can automate?

Reducing panic

Panic occurs when you just stop thinking. Your most basic survival instincts take over, even when they are totally uncalled for. You’re losing money? You start to trade more and more, off-plan, in a desperate gamble to win it back. You’re making money? You close out all your trades right now so that you can’t possibly lose, even if your plan tells you to hold your positions. When you panic, you can’t think straight, and you can’t follow your plan.

One problem is that when your positions are down, and you seem to be losing money, you really should be buying and sticking it out so that you can make money later. That’s tough to do and requires a lot of discipline. Traders learn to avoid panic with experience.

You’re probably going to have more than a few losing trades when you get started. In your trading diary, keep notes about how it makes you feel to lose money. Can you handle it emotionally? If losing upsets you too much, you might not be cut out for day trading. You can’t trade with a clear head if you’re bogged down with negative thoughts.

Confidence versus ego

Day trading requires a lot of confidence, because you are going to lose money and you are going to get beaten up some days. But you not only have to remain confident in the face of adversity, you also have to be careful that you do not cross from confidence into an inflated ego. The more your trading success and failure become part of your personal identity, the more trouble you are going to have.

What’s the difference between confidence and ego? It’s “I’m smart enough to figure out what the market is telling me” vs. “I’m smarter than the market.” The difference is crucial to your success.

Revising and troubleshooting your trading plan

Strong discipline is key to success in trading, but only if you’re disciplined in following the right system. If your trading method is flawed, then sticking to it is going to hurt you. If something isn’t working, don’t get mad at the system; take some responsibility and make some changes.

How do you figure out whether your trading system is right and what changes to make? Go through your trading diary and ask yourself some questions:
  • Why did you choose this system? What is the market telling you about it? Is it telling you that the system works if you follow it, or is it telling you that there’s something wrong with the underlying assumptions. What works for someone else might not work for you. There’s no flaw in admitting that you made a mistake and that you need to make a change.
  • Were your mistakes because you followed the plan, or because you didn’t?
  • What part of the system is causing the trouble? Are you having trouble identifying entry points or exit points? Or are you stuck when it comes time to enter the trade, causing you to miss a point? Or is it that the trades your system identifies never seem to work out? Once you know where the problem is, you can change it.
  • Can you improve your trade efficiency? Is there a way to reduce the number of mistakes? Would automating some or all of your trading help?

One way to get your confidence back while still staying in the market is to trade in very small amounts so that your profits and losses don’t really matter. Trade 100 shares, not 1,000 shares. You give up the upside for a time, but you can also get out of the cycle of greed and fear that has destroyed many a trader.

The Follies of Chat Rooms

Spend any time on the Internet researching day trading and you’ll come across the chat rooms and message boards that some traders use to exchange information. Or at least you’ll come across the chat rooms and message boards that purport to be used by traders to exchange information.

Chat rooms were quite the thing in the first big wave of day trading, in the late 1990s. They don’t have quite the influence that they once did, but some day traders still rely on them. Some are excellent, help people learn to trade, and offer good perspectives on market action. Others are a distraction at best. In this part, I cover some of the benefits and risks so that you know what you are getting into before you make that first post.

Support group or group think?

Many day traders turn to chat rooms for the camaraderie and support they offer. It seems so great to find other people who are going through the same things that you are! They understand what’s happening!

Or do they? I could make a very strong argument that traders who really know what they are doing don’t want anyone else to know who they are or what their plan is. Several successful day traders that I talked to while researching this book refused to have their names in it, because they are happier staying off the radar. Meanwhile, even those day traders who make money have trouble making enough money to stick to the business for a long time.

To compound the problem, the people in a chat room might get so agreeable that they start reinforcing bad advice. Instead of getting support to help you through a rough time, you get dragged down.

In general, a message board that charges a subscription fee is likely to be of better quality than one that’s free, just because the fee wards off the people who aren’t serious. I’ve listed a few in the appendix. But no matter what you pay, spend some time lurking — watching the comments without making any yourself. Proprietors of good message boards usually offer temporary access to prospective subscribers to help them evaluate the service. Check to see how people treat each other, what experiences they have, and how their trading systems match yours. And limit your time and watch your reactions to people’s postings.

Getting angry at nothing

From the very early days of newsgroups and Internet Relay Chat, people exchanging ideas on the Internet have managed to misunderstand each other and blow small things out of proportion. That’s all well and good if you’re talking about the latest season of American Idol, but it’s not so good if you’re day trading. The market is a tough-enough evaluator of your performance. You don’t need to waste time, energy, and confidence on someone who, intentionally or not, makes a nasty comment on a message board.

At a minimum, try to limit your message board activities to market hours. And if you’re one of those people who are quick to anger, it may be best to avoid online discussions with other day traders all together.


Now, here’s one other nasty truth about day trader chat rooms: Sometimes the people posting are trying to manipulate the market and sabotage other traders. They plant false and misleading information, seek to undermine others’ confidence, and otherwise try to seek an edge by bringing others down. In other words, there may not be much information value at all, and the value of camaraderie may be quite low, too.

The Internet is a wonderful thing, and it makes it possible for people to trade sophisticated financial instruments in real time from the comfort of home. But it has its limitations, and online interaction with other traders can actually add to the stress of day trading. Tread carefully.