On Scaling into Trades

07/26/2010 10:34 am EST


While I believe that nobody can predict exact bottoms or tops, we can certainly come close. In light of that belief, we “scale into” our preferred trade setups using 1/3 tranches at a time. Using our backdrop of looking for waterfall decline entry points for reversal profits, we add in some Elliott Wave theory and Fibonacci figures to mix up our recipe.  As we see a trade setup coming around the bend, we begin to scale into our trades as each Fibonacci or wave pattern is reached.

One example is a recent trade I had in BGZ, which is three times short the Russell 1000 Index. The Elliott patterns I interpreted said the overall market rally would wane as we hit 1071/1074, 1085, and 1092. 

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As those areas were hit on the S&P 500, we would purchase 1/3 positions into BGZ, inevitably profiting from the overbought reversal to the downside in the markets. This reversal happened on cue last Friday, July 16. My BGZ position rose 8.5% in just one day of trading, allowing me to enter into a “green” profitable territory on our scaled-in position.

Scaling in eliminates the trader’s desire to let the ego overtake their emotions. By this, I mean your trading system is useless if your emotions can’t be kept in check, both on the downside and the upside. In my own trading, I try to combat that by scaling into and out of positions, forcing myself to buy while others cry…and sell when they yell. It is extremely difficult to go countertrend against the noise of the markets, but certainly, if you plan to do so, you must have a plan of action. 

Trading with emotion is a sure-fire way to lose money in the markets. Taking your time and being methodical with scale-in entry points into a trade reduces your risk of entry and allows for a much greater probability of profits, as well as greatly reduced losses on the trades in which you are wrong.

Never dive “all in” into a trade position, no matter how confident you are of the entry timing, chart, and price. Always scale in methodically. Worst case, the position takes off to the upside for you and you didn’t buy a full position, but that is so much better than going all in on one trade and mistiming your entry, costing your trading account major dollars.

By David Banister of ActiveTradingPartners.com
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