Q&A
Since You Asked
Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.
SCALING OUT OF POSITIONS
I have been following a conversation on a message board on the topic of scaling out. The originator of the post is making a statement about trading psychology and has posted many scenarios trying to prove or disprove a theory about this behavior. For example:
Original poster:
- Four ES contracts 50% win ratio all in/all out versus
- Four ES contracts 50% win ratio scaling out at half target
- Nine-point target three-point initial stop-loss
First example with 20 trades:
- 10 winners for 9 x (four contracts) = 360 points ($18,000)
- 10 losers for 3 x (four contracts) = 120 points (-$6,000)
- Net profit $12,000
Second example with 20 trades:
- 10 winners for 9 x (two contracts) = 180 points ($9,000)
- 10 winners for 4.5 x (two contracts) = 90 points ($4,500)
- 10 losers for 3 x (four contracts) = 120 points (-$6,000)
- Net profit $7,500
Money can be made scaling out, but it represents “inferior” behavior.
Response:
Emini TF futures
- Profit target determined prior to entry to be at $680
- Trader A enters with six contracts at $670
- Profit target reached and trader A exits all contracts at $680 for profit of 10 points x 6 = $6,000
- Trader A total profit at $6,000 via all out
In contrast, trader B enters with six contracts at $670 with the same profit target at $680.
Profit target reached at $680 and trader B determines the price action has become more favorable to the long side when price action reached $680. Therefore, trader B scales out four contracts at $680 for a profit of 10 points x 4 = $4,000.
Trailing stop is at profit and above $680 for the remainder.
Trader B sees price continue to $690 and then determines price action is no longer favorable, designating $690 as the new profit target for the remaining contracts, resulting in exiting the remaining two contracts at $690 for a profit of 20 points x 2 = $4,000.
Trader B is at total profit at $8,000 via scaling out.
This person’s analysis:
As stated by others many times, there’s a time to exit all and a time when you should scale out due to the fact the markets are always changing after entry.
Simply, if you don’t have the ability to exploit those new changes after you open a trade position or you don’t see favorable price action when your profit target has been reached, it’s highly recommended that you close your entire position when the original (primary) profit target is reached.
In contrast, if you have the ability to recognize and exploit markets that has changed after your entry, scale out at your original (primary) profit target and keep the remainders to let them ride to a secondary (bigger) profit target. Next, exit your remainders at their new profit target. If your second profit target is not reached, it retraces and hits your trailing stop at the profit, but it’s still a better exit than trader A has hit.
Don Bright replies:
In my opinion, there really is no perfect answer. Trading is part science, part skill, part timing, and a big part psychology. In my years of training traders, the psychology part has always proven to be the toughest to convey, because, once again, there are no absolutes in trading. I thought this would represent something that will help with the bottom line for most traders:
For what it’s worth, I tell my newer traders something that really seems to help them psychologically (a very big part of trading): When you’re in a position, and you’re not sure what to do, do half. That way, if it keeps going against you, you’re happy you only did half, and if it turns around and goes your way, you’re happy you at least did half. Either way you’re happy, and happy traders are much more likely to make money than stressed-out traders. This example is for a losing trade, same as for a winning trade. Better than just doing nothing.
Another point is most traders let the market tell them what to do. Don’t limit yourself to predetermined profit targets when things are trending your way, and don’t get stuck holding a bad trade when things are going against you. Get out if you think you can get back in at a better price (when the market is rallying like crazy, for example, and you’re short).
My feeling is that there is no right or wrong to scaling out of a position. Scaling in can be another story, but still not wrong in most cases.
In any event, each trader develops his or her own personal strategy and mindset — and if you’re making good money, that’s your proof that you’re right in your assumption.
Don’t fret or worry about what-ifs and other hypothetical scenarios. Do what is best for your type of trading.