Day Trading and the Rule of 5

The average new trader wants to win every trade, which is why they fail.

New traders fixate on win rate. That’s all they care about. They think that a good or bad trade is whether it’s profitable. That’s not true.

If you missed this last night…

Wall Street’s Big 36x Bang

Watch the Replay Here

The Big Picture

You can’t guarantee outcomes. All you can do is trade the highest probability setups with a plan. If the stock fails, that’s why we look for small losses and outsized gains. That’s how trading works.

Try this…

The Rule of 5: A Day Trading Thought Experiment

This is a really good way to think about risk management. Say you trade once a day.

You lose…

• $100 on Monday
• $100 on Tuesday
• $100 on Wednesday and…
• You lose $100 on Thursday

And then you come in and make $500 on one of these stocks. Which is not hard to do with a small account. We catch multiple dollars per share very frequently. So it’s not hard to make $500 on one of these stocks.*

Now, we’re not here to make $100 a week. It’s not our goal, but it’s a thought experiment.

Here’s the deal…

The Math ONLY Works If You Take Small Losses

So, on Monday, Tuesday, Wednesday, and Thursday, you have to take small losses. Now, you can have a very mediocre win rate. In this thought experiment, it’s only a 20% win rate and it is still profitable.

So, if a good or bad trade has nothing to do with whether you win or lose…

What makes a good trade?

A Good Trade Is How You Manage It

You trade high odds setups. Again, you can’t guarantee outcomes. But when the trade doesn’t work, you cut it. You move on.

Now, I recommend a minimum 3:1 reward-to-risk. Again, that doesn’t mean you’ll make that. But when you make a trade plan this is what you’re going for.

But here’s the thing with the Rule of 5…

The math simply does not work if you lose $500 on Monday, $700 on Tuesday, and $1,000 on Wednesday.

The point is, you get to Thursday or Friday and there is no realistic potential for you to get anywhere NEAR profitable. You gotta make $5,000 just to get back to break even.

But if you follow the Rule of 5 you could be 0-for-4 and come in on Friday and very realistically be profitable on the week.

Again, you can’t guarantee the outcome.

But at least it’s feasible.

My Take

Run this thought experiment as many times as it takes for it to sink in. Because if you get bullheaded, trade without a plan, and trade without a stop loss, it’s almost impossible to stay in the game.

Watchlist

Yesterday (May 21) the Wall Street Journal reported that the U.S. Commerce Department is taking an equity stake in nine quantum computing companies as part of a funding deal. This reminds me of what happened with Intel Corporation (NASDAQ: INTC) last year. It’s great news for these companies and America.

I have a whole watchlist dedicated to quantum computing stocks. I’ll stick with the big daddy and two smaller quantums that the U.S. awarded money to keep us at the forefront of this technology.

First up, International Business Machines Corporation (NYSE: IBM).

IBM is expected to receive $1 billion, per the WSJ.

Next up, Rigetti Computing, Inc. (NASDAQ: RGTI) is expected to receive $100 million.

Finally, D-Wave Quantum Inc. (NYSE: QBTS) is also slated for a $100 million investment.

If you don’t have a quantum stocks watchlist, start with these.

On My Radar

• Financial stress leads to faster aging. All the more reason to trade your way to freedom.
• More on the Rule of 5 in this video on the StocksToTrade YouTube channel. Be sure to subscribe.
• More YouTube: Every Sunday at 7:00 PM ET, I answer all your questions LIVE during my Sunday Market Brief. I’m biased, but I don’t think there’s a better way to get you ready for the week.
• Must watch: FREE 60-minute presentation with Jeff Zananiri. Find out why Jeff says “volatility is fuel”. Take notes because Jeff is a no BS trainer who traded billions as a hedge fund manager.

*Past performance does not guarantee future results.