When absolute percentages are considered, the risk-reward assumptions seem to be correct. The rewards of stocks are often larger, but the risk associated with investing in them is also greater. On the other hand, day traders are not concerned with absolute returns or volatility. You did not necessarily make 10% more money on your account just because a stock rose by 10%. During the transfer, you had the opportunity to boost the capital in your account by anywhere from 0.1% to 50%, depending on the value of your account. Even though the stock changed 10%, this move does not suggest that 10% of your money was in jeopardy at any point.
Example of a Low-Risk Trade
Consider that a stock is now priced at $30 and that you have received a signal to purchase the stock. You have an account balance of $50,000 and are ready to risk either 1% of that total, or $500, on the deal. After then, the share price increased by 10% to $33. Not only will the volatility of the stock impact how much money you earn on the transaction, but how you choose to trade within your 1% tolerance will determine how much money you make.
If you purchase at $30 and set a stop loss order for $29.90, the amount of money at stake for each share is $0.10. You decide to invest in 5000 shares of the company, given that you may risk a total of $500 on the deal. Because you need $150,000 to complete the purchase, leverage is required; nevertheless, day traders often employ leverage ratios of 4:1, so this should not be a problem. As a result of the price increase, you decide to sell your shares, resulting in a gain of $15,000 and a profit of $3. You have earned a return of thirty percent on the entire capital in your account.
Example of a High-Risk Trade
Instead, let's say you set your stop loss at $29.50, exposing you to a loss of $0.50 on each share of stock you hold. Therefore, the amount of your holding is 500 dollars divided by fifty cents, which is 1000 shares. At the price of $33, you can sell your thousand shares for a profit of $3,000, resulting in an overall return on account capital of 6%. But the arithmetic is the same whether you're dealing with an asset that moves 0.1% or 15% a day since day traders don't often engage in swings of more than 10% inside a single trading day because such moves are uncommon.
How to Incorporate This Knowledge Into Your Day Trading
Many skilled traders will avoid trading in volatile assets because they believe they need to take on greater levels of risk for the investment to be worthwhile. It is not accurate. You may restrict the amount of potential loss to which you are prepared to expose yourself by using a stop loss order. In trading, everything is related to how much of your account you are prepared to risk, the amount of your stop loss order, and the size of the position that results from those two factors.
Wait for trading opportunities in which you may enter a trade with very little risk by positioning your stop loss order near the moment you entered the deal. No matter how volatile the asset is, if you are patient and wait for chances like this, you can take higher position sizes while limiting the risk you are exposed to.
You don't have to trade volatile stocks if that's not your thing; you may trade more stable equities and still generate significant profits. When trading volatile stocks, you may do this by trading bigger positions, which means using a greater position size about the deal's value. You have complete command over the level of risk you expose yourself to when trading any stock or asset since you decide the size of your positions, which ultimately determines how much money you earn.
Conclusion
Try to steer clear of thinking in absolute terms. "Stock changed 10%, and depending on how I traded it, I might have earned or lost 10%." It is important how each trader decides how much risk and profit they are willing to take, which determines the size of their positions.
You have the option of taking a smaller position size with a greater stop loss, or you may choose to take a larger position size with a lower stop loss that is closer to the entry price. In either scenario, the risk is kept under control, but if one is patient and waits for chances in which the stop is tiny (which indicates a bigger position), the potential payoff is enormous. Almost any asset may be transformed into a fantastic trading opportunity.
