The world of day trading offers many opportunities. However, with opportunity always come risks. A successful day trader who has generated huge profits can also lose everything in a couple of poorly chosen and badly managed trades. In order to counter risks in day trading, there are risk management tools every day trader should use. Stop-loss and take-profit targets, careful planning of each trade, and discipline in following one’s trading routine are essential. Here are a few more important tools for managing day trading risk.

Volatility Indicators

By using volatility indicators a day trader can better measure and understand the current degree of volatility in the market no matter which type of assets they are trading. A commonly used tool is the average true range or ATR. The ATR is derived by taking the current market high minus the current low, the absolute value of current high minus the prior close and the absolute difference between the current low and the prior close. These values work as a moving average that provides the day trader with a snapshot of how mild or intense volatility is in markets such as commodity futures.

Position Sizing Calculators

If one were in possession of a perfect day trading strategy that removed all risk, the logical thing to do would be to trade large positions for greater and greater profit. In real life day trading, risk is always present, thus a disciplined day trader varies his or her position sizes according to perceived trade risk and how much capital they can afford to put at risk. A way to do this is with position sizing calculators. These risk management tools can be set for the amount of risk that you are willing to accept with your trading capital and will help you decide, in turn, on how much to risk in each trade.

Trailing Stops

As we have noted, setting take-profit and stop-loss targets protects day traders from rapid and unexpected market fluctuations. When one is following a market trend that continues and continues, it may require the day trader to repeatedly adjust these targets. By doing so they maintain further profit potential while limiting losses. A way to avoid having to repeatedly adjust stop-loss targets is to use trailing stops. Trailing stops are stop-loss targets set for a fixed amount below the current market price. When the price of an asset keeps going up, so does the stop-loss target. Thus, when the asset price does eventually correct downward, it only corrects downward by the trailing stop amount before the stop-loss takes effect and not back to where one originally entered the trade and set a target.

Correlation Analysis

You are trading futures in a commodity such as crude oil or coffee. Both are priced in dollars for international trading. So, while nothing special is happening in the oil or coffee worlds, the price of the dollar surges upward as the US Federal Reserve raises interest rates and indicates that they will continue to do so to fight raging inflation. Both coffee and oil prices fall. When using correlation analysis it is important to remember that one can calculate correlations, both positive and negative, this does not explain why the correlation occurs. Before proceeding with a planned trade it is always wise to have a clear idea of why the correlation occurs and never to neglect setting both stop-loss and take-profit targets.

Monte Carlo Simulation

There are tradable assets that may offer extraordinary profit potential but also carry extreme risk due to their unpredictability. The first thing to remember in this context is that you will never lose money if you avoid trading in a context where you are not able to establish a reliable strategy for trading. There is no penalty for watching a market develop as you seek to understand it and then keeping your trade entries and exits extremely brief in order to control risk. To the degree that one wishes to enter such markets one can use what are called Monte Carlo simulations. These statistical approaches are generally applied to situations where price fluctuations are more greatly determined by apparently random variables and not predictable by the technical analysis tools available to the disciplined day trader. These tools can be useful for stress-testing trading strategies in simulation in order to determine the degree of risk such strategies pose.