Today, I plan to share the investment insights Benjamin Graham, Warren Buffet’s mentor, gleane...
To Scale or Not to Scale?
11/09/2012 6:00 am EST
Whether to scale in or out of trades is a common question among traders, and CoachShane of NetPicks.com writes that the answer depends on what your priority is in trading.
In my swing trading of the currency markets, many times I take some profits off the table and keep them safe in the confines of my trading account. The reason I do it is not only a psychological one, but a risk control measure as well.
Humans love to be right. In trading, the market is always right and I totally accept that at any time, price can turn against me and take back the unclaimed profits that were sitting there. By taking a piece out of the market and banking some profit, I feel good. Not only do I feel good but it allows me to handle any retrace in unclaimed profits in a more relaxed manner. After all, I am not a robot that can enter and exit the markets without a hint of emotion. If I see a full position giving back some of the profits, it bugs me. Banking some profits at certain areas of the chart (structure) really simmers down the irritation of “giving back” to the markets.
I look at my trading account as business capital. Like many businesses, we never really know if the next investment in anything will pay off. Sure, we look at probabilities (much like any business does on ROI) but that is about the extent of our control. Either we get involved or we don’t. Neither you nor I can control if the next trade we plunk our capital down on will pay off. I accept that the unknown variables are truly unknown and even though my plan says take the trade, whether it works out depends on other factors. The markets are uncertain and scaling out lessens exposure for the unexpected. I can control entering the position. I can also control my risk. For me, the priority is not to avoid loss (surprised?) but to limit the impact of any loss. I know I am going to lose trades and controlling risk, for me, is the utmost importance.
When scaling out, I don’t even have to move my stop to lessen the impact of a loss. (Heck, I don’t even have to worry about catching the big move to make money).
Let me show you a simple example using the currency markets.
1 standard lot buying in with a 20-pip stop loss. Maximum loss is $200. If I scale out a portion of 3 at +20 pips and bank $60 that leaves me with 7 mini lots in the market. If price takes me out, the loss is $140. That is if I don’t move my stop.
To keep this going…scale out a portion of 3 at +40, which banks $120. I then move my stop to break even after banking $180. Regardless of what happens now, I will have taken profit...been PAID…on this trade. My goal is not to reach targets but to make money.
I then have 4 minis still riding in the market where I can now trail the stop up under market structure.
As well….I have now free capital to use to get back into the market if the conditions are present.
Another thing, which really does not matter to the average FX retail trader is slippage but let me quickly cover it.
If I am long a position and scale out with price going up, what is the chance of slippage? Next to zero for negative slippage because although I trade decent size, it is a blip in the overall scheme of things.
Is this the optimal way of banking profits? I don’t know, however many simulations show that staying with full position sizing throughout the trade is more profitable. I do know that the answer to this still evades me. Some trades I do not scale out while others I do. That is a weakness I have in my own trading, which is I don’t have it set in stone. I actually go by gut feel, which is not always the most optimal way to make a decision.
The scale topic becomes the heated debate in some forums with each side taking the extreme view that their way is the best. For me, I ignore all the experts. I accept that I may not be doing the “optimal” thing right now and there are areas of improvement for me. However….I do what is right for me. What do you do?
By CoachShane, Contributor, NetPicks.com
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