Scaling Positions

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Introduction

Scaling is adding or subtracting units from your open positions.  Scaling allows traders to adjust overall risk, lock in profits or maximise your profit potential.

Benefits and Drawbacks

The main benefit is that scaling allows traders to enter positions gradually, which reduces the initial risk.  It also allows you to take-off small parts of your position thus locking in profits.  These two benefits have a huge psychological impact on traders, as traders don't need to get it right all of the time when scaling.

The main drawback is when you add to a position, exposure and overall risk on capital increase.  We'll explore the best way to scale-in later in this module.  On the flip side, when you take money out of an open position (scale-out) you reduce your potential profit.

Scaling Out

Scaling Out means taking exposure out of winning or losing positions. Let's take a look at a simple example (we won't calculate Forex Position size here) where a trader scales out of a winning position.  The trade is shorting EUR/USD: 
  • You have a $10,000 account and you shorted EUR/USD at 1.3000. 
  • You placed your stop at 1.3100 and your profit target is 300 pips below your entry, at 1.2700.
  • Your total risk is $100, or 1% of your account (see Position Sizing).
  • A few days later, the EUR/USD has moved lower to 1.2900, or 100 pips in your favor. This means you have a total profit of $100.
  • An ECB member comments The ECB may increase interest rates soon, which may bring buyers back into the market.  You think you should lock in some profits.
  • You decide to close half of your position at the current rate of 1.2900.
  • This locks in $50 of profit into your account. You have closed a profit of 100 pips.
  • This leaves you with an open position of $50 - still shorting EUR/USD at 1.3000. From here, you can adjust your stop to break-even (1.3000) to create a "risk-free" trade (not taking into account "slippage").
You have to weigh the pros and cons -  better profit versus the peace of mind of a smaller locked-in profit and creating a risk-free trade.  Whatever your decision, it must fit in with your overall strategy.

Scaling In

You can scale in to losing and wining positions.  New Traders should NOT scale in to losing positions. Scaling in to a losing position, can increase losses substantially if you don't know what you're doing.  This is one for the Pro's, so we won't talk about scaling in to losing positions at this point.

Scaling in to wining positions is done by trend traders and shouldn't be done if trading in a range.  When scaling in traders should always take into account their total risk, calculate the position size on every trade and set a trailing stop.  Let's look at an example where the traders total capital is $100 and the risk is 1% (or as near as damn it) throughout the total trade.
  • Trade 1. Buy a stock at $10 with a target of $13.  Stop placed at $9 - a $1 (or 1% of total capital) risk.
  • Trade 2. Things are going the traders way - UP. He/She decides to buy 1 more stock at $11, while moving the stop to $10.  This means risk on trade 1 is now zero (the new stop is the same as trade 1 entry price) and the new risk is $1.  Total risk is still $1
  • Trade 3. The stock is still going up, so once again the trader scales in, buying 1 stock at $12 with the stop now moved to $11.  Here, the original trade is in profit by $1, the second trade has zero risk and the 3rd trade has a $1 risk.  Total risk is now zero
  • The stock reaches the target $13, so the trader sells all 3 positions.  Profit totals $3+$2+1 = $6.  If there was no scaling in profit would be $3.
You have to be aware that adding to winning positions may not be the best tool for every market environment or situation.  In general, scaling into winning positions is best suited for trending markets or strong intraday moves.  Because you are adding to a position as it goes your way, your average opening price moves in the direction of the move as well. What this means is that if the market pulls back against you after you have added, it doesn't have to move as far to get your trade into negative territory.

To Sum Up

It's important to remember:
  • Always use stops and trailing stops, or other management techniques like the use of options.
  • Don't add to losing positions until you are more proficient
  • When scaling-in remember to keep managing risk
  • Remember to calculate your position size on every scale
  • Scale-in on trending markets
Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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Introduction

Scaling is adding or subtracting units from your open positions.  Scaling allows traders to adjust overall risk, lock in profits or maximise your profit potential.

Benefits and Drawbacks

The main benefit is that scaling allows traders to enter positions gradually, which reduces the initial risk.  It also allows you to take-off small parts of your position thus locking in profits.  These two benefits have a huge psychological impact on traders, as traders don't need to get it right all of the time when scaling.

The main drawback is when you add to a position, exposure and overall risk on capital increase.  We'll explore the best way to scale-in later in this module.  On the flip side, when you take money out of an open position (scale-out) you reduce your potential profit.

Scaling Out

Scaling Out means taking exposure out of winning or losing positions. Let's take a look at a simple example (we won't calculate Forex Position size here) where a trader scales out of a winning position.  The trade is shorting EUR/USD: 
  • You have a $10,000 account and you shorted EUR/USD at 1.3000. 
  • You placed your stop at 1.3100 and your profit target is 300 pips below your entry, at 1.2700.
  • Your total risk is $100, or 1% of your account (see Position Sizing).
  • A few days later, the EUR/USD has moved lower to 1.2900, or 100 pips in your favor. This means you have a total profit of $100.
  • An ECB member comments The ECB may increase interest rates soon, which may bring buyers back into the market.  You think you should lock in some profits.
  • You decide to close half of your position at the current rate of 1.2900.
  • This locks in $50 of profit into your account. You have closed a profit of 100 pips.
  • This leaves you with an open position of $50 - still shorting EUR/USD at 1.3000. From here, you can adjust your stop to break-even (1.3000) to create a "risk-free" trade (not taking into account "slippage").
You have to weigh the pros and cons -  better profit versus the peace of mind of a smaller locked-in profit and creating a risk-free trade.  Whatever your decision, it must fit in with your overall strategy.

Scaling In

You can scale in to losing and wining positions.  New Traders should NOT scale in to losing positions. Scaling in to a losing position, can increase losses substantially if you don't know what you're doing.  This is one for the Pro's, so we won't talk about scaling in to losing positions at this point.

Scaling in to wining positions is done by trend traders and shouldn't be done if trading in a range.  When scaling in traders should always take into account their total risk, calculate the position size on every trade and set a trailing stop.  Let's look at an example where the traders total capital is $100 and the risk is 1% (or as near as damn it) throughout the total trade.
  • Trade 1. Buy a stock at $10 with a target of $13.  Stop placed at $9 - a $1 (or 1% of total capital) risk.
  • Trade 2. Things are going the traders way - UP. He/She decides to buy 1 more stock at $11, while moving the stop to $10.  This means risk on trade 1 is now zero (the new stop is the same as trade 1 entry price) and the new risk is $1.  Total risk is still $1
  • Trade 3. The stock is still going up, so once again the trader scales in, buying 1 stock at $12 with the stop now moved to $11.  Here, the original trade is in profit by $1, the second trade has zero risk and the 3rd trade has a $1 risk.  Total risk is now zero
  • The stock reaches the target $13, so the trader sells all 3 positions.  Profit totals $3+$2+1 = $6.  If there was no scaling in profit would be $3.
You have to be aware that adding to winning positions may not be the best tool for every market environment or situation.  In general, scaling into winning positions is best suited for trending markets or strong intraday moves.  Because you are adding to a position as it goes your way, your average opening price moves in the direction of the move as well. What this means is that if the market pulls back against you after you have added, it doesn't have to move as far to get your trade into negative territory.

To Sum Up

It's important to remember:
  • Always use stops and trailing stops, or other management techniques like the use of options.
  • Don't add to losing positions until you are more proficient
  • When scaling-in remember to keep managing risk
  • Remember to calculate your position size on every scale
  • Scale-in on trending markets
Technical analysis is not an exact science and although these ideas can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

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