The scaling out technique is one of my favorites for reducing stress if the market quickly turns in my favor. If I take just a little portion of my winning position off the table to lock as profit, I will have more room to breathe and less likely have a panic attack if my trade still has a long way to go.
Although the right side of the chart has a tendency of creating anxiety, I always try to find a signal of any sort that might just tell me whether or not it’s a good time to get rid of the randomness while making a trading decision.
Scaling is a good way to make more profits if your signals are hinting that the trend is going strong in your favor.
Let’s talk about how to make sure that your risk is under control when you’re scaling or adding to a position. Use calculations for proper trade sizing and keep your risk percentage in line.
Scaling out of a trade is a technique, or even an art, that can convert failing trades into money-makers. It can reduce stress and definitely increase your bottom line.
Use the scaling technique for trend trading, scalping and countertrend trading. It works on any time frame.
Reducing stress is important during a trade, it lets you focus on the trading instead of being subjected to emotions like fear and greed. If you scale out of the positions properly, you can not only become more profitable, but reduce your stress significantly as well.
Here’s the thing:
To be able to scale out of the trades, you need to make your initial trade size big enough so you can reap the benefits of scaling out.
The technique can be applied in both long and short positions and for pretty much any market, whether it is future, stock, index, or option.
The key idea is to set a large enough trade size without risking over 2 percent at the entry point.
The most important part is that during a scaling-out, your trade size in contracts needs to be large enough to take one-third of your position out when you feel the signal to do it.
You can take out another third with another signal afterwards. The last third stays until the end.
Scaling out can be like an insurance policy to lock profit. It’s a great technique that can be used in a lot of different ways and can be tested on your own approaches to see what works better for you.
To warrant scaling out, you need to set a large enough trade size and have one contract so that the trade won’t get you anywhere. It’s better to have at least three to be able to make the technique work the way it should. In addition to a big enough trade size, you should keep your trade risk under 2 percent.
Two ways to increase trade size while maintaining solid risk control:
Another good idea is to use options leverage, but be familiar with the options. It means you need to understand their time value decay, delta, etc. Using options is considered a specialty or even an advanced technique. If you’re not familiar with them, this method can just lead to increases in stress and risk.
Let’s take the E-Mini as an example. Your account size is, let’s say, $20,000 and you decide to risk 2 percent on this trade. 2 percent of this number makes $400. Your trade entry is 1017.75 and your exit is 1019.25. Having these values, you can buy around six contracts and stay safe and out of risk.
This example will show a risk of 1.5 points per contract valued at $50 per point. If you stop out before having the opportunity to scale out, your loss will only make 2 percent. It means your potential risk won’t cause stress.
Once your trade becomes profitable, scaling out will come into play. At the point of your trade when it gets significantly beneficial, a part of the position should be covered and there should be enough liquidated contracts so that if you ever get stopped out, you could still make a profit.
If you happen to have a large enough trade size, then it might be a good idea to liquidate another portion of contracts just to lock up additional profit. The last portion shouldn’t be touched.
Until you get stopped out, enjoy the rest of the trade and let it continue as long as the trend exists, knowing that no matter what happens, you will still make a profit, either way.
Look for reverse signals that might tell you to scale out. Make up some rules to work according to a plan so your scale outs are based on technical or fundamental signals of some type.
If you’re trading only one or two contracts you aren’t able to scale out meaningfully. This is just another reason why larger trading accounts have advantages over the small ones.
Some markets, by the way, are more expensive than others, therefore the prices of shares and contracts determine your trade size.
It all comes down to this – when choosing a market, remember that liquidity is important. You should have sufficient market liquidity to scale out successfully. Poor liquidity can cause poor fills that may affect the technique adversely.
The psychology of scaling out is to reduce stress by locking profits, which should help you to stay in trends with your leftover positions for a longer time.
Because we are discussing money management and risk control, it would be a good idea to talk about how to control risks using the popular strategy of adding to trends to increase trade size and profits. This technique is called scaling, or “adding to” a trade in progress and usually is used in the trend trading.
In general terms, it is for increasing your trade size on the up and running trades while maintaining the strict risk control throughout the whole process. The reason for scaling into a trend is to gain more profit.
The important thing is to distinguish scaling in from another technique known as doubling down, which is, by the way, a form of adding. Unfortunately, doubling down also increases your trade risk.
Doubling down lets you add to your trade size when it goes against you and when your open trade is losing.
When you add to your position at a loss, you increase your trade size and lower your cost basis. But you also increase your trade risk. Due to this, the new added-into position will assume risk in addition to the risk of your initial open trade.
So now you have an increase in the overall risk of your trade. For this reason, doubling down can be a losing game, since your risk increases beyond the risk-of-ruin percentage guidelines that are used for the careful calculating of the trade size, which determines your trade risk on the initial position.
A new and even better way to add to your position is to add only when your stop-loss on the trade size moves to a better price range without such a risk, or even with no risk at all.
It means that your initial trade will either be break-even or profitable if you’re stopped out. Moving your stop-loss at this time is called a trailing stop.
Think about it this way. When you add to or scale into a trade using this technique, you don’t incur additional trade risk because your new trailing stop loss nullifies the risk taken from the initial position.
And if you scale into, you do it with the trade size that is calculated carefully enough to not do any damage. Afterwards, your overall trade risk will be the only one.
A final word of caution needs to be mentioned in regards to the scaling into or adding to any position. Even if we control the trade risk by our careful calculations, we still don’t control the market risk.
Trade risk is the one that is based on the stop-losses and trade sizes we set. But market risk is basically represented by the unforeseen events that cause gaps and bad stop-loss fills that have power to offset any predetermined trade risk we have planned.
Because of the market risk, we always trade with the risk capital and mind our overall portfolio risk.
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