Leave Day Trades Alone or Manage Them Actively?
Pros and Cons of Two-Day Trading Styles
You find a trade setup, know where to get in, know the stop loss level and know where you want to take your profit (target). The next question is, do you let the price hit your stop loss or target, and do nothing until that happens? Or, do you allow yourself to alter these levels, adapting to current market conditions as the price moves around? Both are viable methods, but it depends on how they are employed. After examining the pros and cons each method, stick to the method that better suits your strategy, personality, and skill level.
The Hands-Off Approach
The hands-off trading approach is when a trader places an entry order along with a stop loss and target order. Stop losses and targets are offsetting orders that keep a loss to a reasonable amount (typically less than 1% of trading capital) or exit the trade at a reasonable profit for the conditions. Once in a trade, with the stop loss and target orders set, the trader simply waits. Eventually, the price will either hit the stop loss or target, concluding the trade.
No matter what the market does, the trader lets the price hit the stop loss or target. The only exception is if there is news coming out, or it is the end of the trading day. In both these cases, close all day trading positions just prior to scheduled news releases or at the end of the day.
The hands-off approach doesn't mean the trader is sitting there doing absolutely nothing while they are in a trade. They can continue to analyze the current price action, or find trades in other instruments.
The Active Management Approach
With an active management trading approach, a trader has the flexibility to adjust stop loss or target levels, and/or exit a trade earlier than originally planned. The trader may also choose to stay in a trade longer than originally planned (see: How Long to Hold Your Day Trading Positions), in an attempt to make a more sizable profit.
Active trade management gives a trading strategy more flexibility since the trader can adapt to what the market does during a trade. If the price doesn't do what they expect, they can close the trade immediately or move the stop loss closer to the entry point so they reduce the size of their loss.
If the price moves aggressively toward the target, they can push their target further away from the entry point, increasing the potential profit. Alternatively, they could simply exit the trade as soon as momentum slows.
If the price moves toward the target, but then starts heading the other way, the active-management trader can simply close the position, preventing a winning trade from turning into a loser.
As the price moves toward the target, an active-management trader could move the stop loss toward the target, reducing the size of the loss (or locking in again) as the price moves further toward the target. This is called a trailing stop loss. Typically day traders will only reduce their risk by moving their stop-loss toward their entry point and target once in a trade. Expanding the stop-loss—moving it further away from the entry point and target—likely means the trader is unwilling to accept the loss or had a poorly planned trade and is now increasing their risk in the hope that the price will turn around.
Hope doesn't belong in day trading.
These are some of the tactics that can be employed with an active trade management approach. Some of these tactics sound very good, in theory, but don't rule out the hands-off approach. The active management approach has drawbacks as well.
Pros and Cons of the Hands-Off Approach
The hands-off trading approach—taking a trade and letting it hit the stop loss or target—is a much simpler form of trading than the active management approach. For this reason, new traders should stick with the hands-off approach.
The hands-off approach allows for simple math to do the work. If a trader wins approximately 50% of their trades and has a target that is bigger than their stop loss, they will produce a profit. The profits are based on a balancing act between win-rate and risk/reward.
The hands-off approach allows traders to easily track statistics and see where they are having problems. For example, since the stop loss and target orders don't move once a trade is placed, a trader can look back over many trades and determine if they could alter these levels slightly (on all their trades) to produce better results. A trader may notice that their win-rate is dropping and that the price is moving toward the target (but not reaching it) but then reversing and hitting the stop loss.
This insight allows the trader to reduce the target slightly (on all trades), which will produce more winning trades, improving overall profitability.
This example shows the drawback of the hands-off approach. A trader needs to make adjustments to all trades (by altering their strategy), not just the current one. The trader has no leeway on individual trades to take a larger profit if the price moving very well or to take a smaller profit/loss if the price isn't moving well. That said, unless the trader knows when to get out of trades early or knows when to stay in for a larger profit (what are your signals to do so?), the hands-off approach is best.
Pros and Cons of the Active Management Approach
Active management day trading requires much more skill and psychological control than the hands-off method. Though, in the right hands, it can be a powerful approach.
The main benefit of the active management approach is that a trader is allowed to adapt to changing market conditions during a trade. While analysis is done prior to the trade, something may change while in a trade. For example, the trader may have bought but then notices a reversal pattern forming on the chart. The price is no longer likely to hit their target. The active management trader absorbs this information and exits the trade before it turns into a loss.
It is quite likely that an active management approach will result in more winning trades because the trader can exit for a smaller profit (instead of letting it hit the stop loss) if the price isn't moving as expected. The danger is that it can become very easy to just always take small profits. Small profits are fine every once in a while, but if losses (when they occur) are larger than all these small profits, the trader could end losing money overall even though they are winning 60% or 70% of their trades.
Since the trader knows they can get out early, they may become lax in their trade selection. Instead of waiting for the really good trades with good profit potential, they may take any trade since they know they can get out with even a tiny profit. But such trades typically aren't high probability and are unlikely to produce sizable gains or an overall profit over many trades.
Active trade management is more stressful since decisions are constantly being made in real-time. With each price move the trader has decisions to make: Stay in? Get out? Move the stop loss? Move the target? Such pressure can result in poor trading decisions because discipline, which is like a muscle, can become fatigued.
Most traders will perform better with the hand-offs approach because there is less to think about and less skill involved. With years of practice, though, an experienced trader should be able to make more money with an active management approach. Winning trades aren't allowed to turn into losses, winning trades are maximized by adjusting the target to match current conditions, and losing trades are minimized by getting out when the price doesn't act as expected. All this means that losing trades should be slightly smaller on average than the hands-off approach, and the average winning trade will be of similar size to the hands-off approach (because some wins will be smaller, but others will be bigger).
Because of the adaptability, the experienced active management trader will likely have a higher win rate than the hands-off trader.
There are pros and cons to the hands-off and the active-management trading approaches. If you are just starting out, use the hands-off approach. This approach allows you to more easily see where potential problems lie. Also, you will be able to watch price movements unfold (once in a trade) without the psychological pressure of having to adjust your orders based on those price movements. The hands-off approach works well as long you monitor your results and make subtle changes to your overall strategy as market conditions change from month to month.
This way, your win-rate and risk/reward ratios stay in balance. Remember, you are not interfering with individual trades, but you can change your overall strategy/trading plan as you notice strengths and weaknesses over many trades.
As you watch prices move, you will gain experience in spotting when you should be exiting trades early and when you should be staying in trades longer than you originally expected. As this skill develops, you may opt to switch to an active management approach...but you don't have to. Active management requires more focus and discipline, so it takes plenty of time to harness the profit potential of adapting to current conditions.
Start with the hands-off approach and then gradually move toward active management. Consider comparing the two approaches, especially once you start using active management. If you are using active management, also record what your daily results would have been if you had used the hands-off approach. It is quite possible that your results may be better with the hands-off approach. Stick to whatever method produces the best results. This way, math decides what the best approach for you is, and not the ego.