Professional traders use a number of tools and techniques to manage risk effectively. Without proper risk management, you will always be vulnerable to catastrophic losses which can occur at any time. By making sure your losses are always kept to an acceptable level, your trading performance will improve and you won’t have to deal with the pressure of high risk. One tool you can quickly implement to limit losses is the Daily Loss Limit. In this post, I’ll go over what the DLL is and how to determine your DLL.
What Is the Daily Loss Limit?
Simply put, your Daily Loss Limit, or DLL for short, is how much money you can afford to lose in a trading day.
When you reach your DLL, you should close your positions because something is going wrong. You are already losing money, so cut your losses and call it a day. Let your emotions cool down and try to review what happened so you can prevent the same scenario from happening again.
It’s well known that all traders have losers sometimes. When a trade goes against you, it’s better to cut your loss than let it snowball into a disastrous loss. Most traders use the Daily Loss Limit to keep their losses at a reasonable level.
How to Set Your Daily Loss Limit
Generally, traders recommend that your DLL never exceeds 2–3% of your capital. If you’re still new to trading, you should start with a very low DLL and gradually increase it as you get experience and build a track record.
Here is another way to set your DLL. I recommend setting your average good trading day as your DLL. Let me explain why.
If you lose more than what you usually make on a good winning day, then you will need to have one of your best winning days just to make back what you lost. And the probability for this is rather low.
Furthermore, you will feel a huge psychological pressure while trying to make back your losing day, and that can cause you to make trading mistakes.
By setting a clear Daily Loss Limit and sticking to it, you protect your account from the possibility of taking a huge blow in a single day.
That’s why your DLL should be equal to your average good winning day.
Use this simple tip to calculate your DLL
Here’s a quick tip: to calculate your DLL, simply look for the midpoint between your average winning day and your best winning day over a period of time.
For example, let’s say that, on average, you make $400 on a winning day, and your best day in the last 30 days netted a profit of $1,000. Your Daily Loss Limit should be $700. If you lose $700 in a day, you stop trading.
In Conclusion
The Daily Loss Limit is a very effective tool for managing risk in trading. By setting a limit to how much you lose in a single day, you’ll keep your losses in check so that you won’t need several great winning days in a row (an unlikely scenario) to make back what you lost.
For all its usefulness, the DLL is only one risk management tool among many.
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