Minimizing risk is crucial when day trading stocks or even investing long-term. Without proper risk management, you may end up wiping out weeks, months, or even years of profits in just one trade. Unfortunately, this happens to most new traders at some point in their new career. As brutal as it may be to experience, this exact situation can really engrain the importance of risk management into your brain, which can benefit you greatly in the future. If you’ve already gone through something like this, make sure you learn from your losses and remember to do everything you can to manage risk in the future! Otherwise, this article should help you greatly to be able to manage your risk and keep your losses affordable.

First, it’s important you understand some basics of technical analysis like support and resistance. We’ll be using these chart levels to find where to cut losses if a trade happens to move against us. This process of cutting losses is exactly how we manage risk as traders.

Support is a price where a stock historically has a difficult time falling below due to stronger buying (demand) than selling (supply). Generally speaking, when a stock breaks below support it is a major sign of weakness and the stock is likely to continue lower until new support is formed. See diagram #1.

Resistance is a price where a stock historically has a difficult time breaking above due to stronger selling (supply) than demand (buying). Generally speaking, when a stock breaks above resistance it is a major sign of strength and the stock is likely to continue higher until new resistance is formed. See diagram #2.

Now, there are also “false breakdowns” below support and “false breakouts” above resistance. Sometimes while managing risk these false breakdowns and false breakouts can cause us to get faked out, but it’s better to be safe than sorry because it only takes one large loss to ruin weeks, months or even years of progress. See diagram #3.

These simple lines of support and resistance are really all you’ll need to be able to create a trade plan and effectively manage your risk. Your trade plan should be put together before you even enter the trade and should be made up of 2 main points.

The first of these points is your profit target. Your profit target is a price where you’ll lock in some profits if the the trade moves in your favor. Something to keep in mind is that you don’t have to exit your full position at your profit target. You can sell half your shares and hold onto the other half if the stock that you're in is still looking strong and has a good chance of continuing higher. At the same time, you should remember that you made that price a profit target for a reason. That reason is usually because of resistance on the chart and you need to respect that resistance and be safe by locking in at least some of your profits at your profit target.

The reason that we use resistance as a profit target it simple. Stocks often run into a level of resistance and reverse to the downside. By setting your profit target just below a level of resistance, it allows us to sell and lock in our profits at the top of a move before the next pullback or reversal. See diagram #4.

The other half of your trade plan is going to be your risk level. This is the price that you’ll cut you losses and exit your position if that trade happens to move against you. Since we know that stocks often continue lower after breaking below support, support levels can also be used as risk levels. If you buy into a stock expecting a bounce up, but the stock breaks below support… you should quickly exit your position and cut your losses just below that level of support. See diagram #5.

Having a trade plan with a profit target and risk level before you enter your trade can also greatly minimize the stress involved with trading. It takes the unknown out of the market. You now know exactly how much you stand to lose if the trade happens to move against you! A bonus tip that can help you avoid higher risk trades is to only enter a trade if the profit target is at least 2x away from your entry price as your risk level.

For example, if you’re considering buying a stock at $5.00 and your risk level would be $4.80 ($0.20 risk) based on the nearest chart support… you would only want to take that trade if there was no major resistance until $5.40 or higher ($0.40 reward).

You can still be a consistently profitable trader with less than a 2-to-1 reward-to-risk ratio, you would just need to have a higher accuracy. At the end of the day it just comes down to your personal trading strategy, but the one thing that should be similar with every strategy is having a defined level of risk.

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