Before you can figure out how to manage your day trading, 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 x loss on losing trades + % of winning trades x gain on winning trades = expected return
Which in this example, works out to be:
.40 x –.01 + .60 x .015 = –.004 + .009 = .005
On average, then, you would expect to earn 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.