Friday, April 08, 2005

Scale-In

I was trading the Defense last week and I was able to work it profitable. Still I see the dangers and being at the mercy of the market once a move against your position starts, isn't fun either.
 
Croc_60
And if you were caught long in this downmove no defense would have helped you. There were just not enough retracements to get you out.
 
I myself worked a defense the other day, when Euro made the double bottom at 1,2866 with entries at 1.2901 and 1.2981. It took quite some time to get out of this trade with a profit. It worked, but I can tell you, it got me thinking about the strategy again.
 
But maybe I’m looking at it the wrong way.
 
I’m thinking for quite some time now about trading a second contract. My account warrants it, the probabilities tell me it is time and trading the defense showed me I no longer have the “panic” feeling once I hold not one but two contracts in a volatile futures instrument. I can think in a clear, detached way, regardless whether the trade is at a loss or at a profit, so it’s time to take the next step.
 
But how?
There are different methods available of course.
  • All in, All out
  • All in, 1. Exit at 5–7 ticks and a Runner 
  • Scale in once the trade becomes profitable, Exit at a target
  • Trade 2 contracts with a Defense
  • Scale in, if the trade goes against me, Exit at a Target or Scale out

All in, All out is the method most might use in these tighter ranges we see today. This method has the advantage, that statistically you can double the results you are currently seeing, as you just have to continue doing, what you do with 1 contract.

As popular is the method All in, Exit one at 5 ticks, bring the whole trade at BE+1 at the then lowered Entry price and let the Runner go as far as it goes. This strategy requires Follow-Through which we seldom see nowadays. But if it runs, it’s a great strategy.

Even more Follow-Through dependant is the Scale in at a profit method. You add contracts once the trade becomes profitable (eg. at every retracement or every 10 ticks profit add one and trail the Stop up). That’s a method most suitable for swing traders trading longer timeframes. If you go for a trend trade on the Euro for 110 ticks, you sure could add every 20 – 30 ticks and still have the Stop far enough away. But the Risk:Reward Ratio of this trade isn’t very favorable. Every time you add, your average Entry price goes up, making the risk on the whole trader higher in later stages of the trade.

Scale-In into a losing trade. That’s what the Defense (see my other articles about the strategy) is doing. But other than the Defense a Scale-In uses Stops under the position, so you can continue the other day. Where you put these Stops is at your discretion obviously, but contrary to the Defense you use Stops. Let’s examine that thinking.

I don’t expect to enter at a Top or Bottom. It’s nice if you enter and your contract never looks back, but how often does it happen? 1 in 10 trades, for me it’s more 1 in 50 trades. Usually my trade wiggles around my entry for a while before I’m proven right or wrong. And I want to enter with 2 contracts. So why not enter once I get my signal with 1 contract and put the entry for the second contract 10 ticks below for the Long entry? The Stop goes in at 15–20 ticks, which I usually use, when trading Euro.

Let’s give an example:

Long 1.2835, Add-On 1.2825, Stop for 2c at 1.2815

If we go, fine, I’m in with 1 contract not with 2, but the Signal proved to be worthy of my entry and I can expect a better move. If it goes 10 ticks against me, I’m in with 2 contracts, my average entry price is down another 5 ticks to 1.2830, which brings the position into the intrabar wiggle range again, giving me the high probability to exit the trade at Breakeven + 1, even when the signal should really be failing.

The Stop is at 1.2815 for 15 ticks on the position. (Had you entered All-In the Entry would have been 1.2835 with Stop at 1.2820 for the same kind of Risk, but giving Euro 5 ticks less wiggle room)

The Exit on the Add-On contract goes in at 10 ticks profit to make sure we have a winning trade once taken out. Of course you could instead decide to just put the Stop at BE + 1 for the whole trade. Still, if that Stop is hit, you are out for 2 ticks, while taking a risk of 15 ticks on the trade. No, exiting just one and trailing the Stop for the whole trade to 1.2826 to again give Euro air to breath, while still minimizing your risk on the trade is the better way to go in my oppinion.

What’s the difference to the Defense? The defense tells you to enter at multiple levels down to trade yourself out of the hole. If you have anything resembling a rangebound market even if you have wide ranges that’s fine. But look at the margin needed.

To trade a 5 level defense you have to have in your account for every contract traded at least 6 times the margin needed by the exchange plus safety level. So for the Euro to trade 1 contract with a 5 level defense, you need a margin of at least 20k, as in the end you will be Full-in with 6 contracts. If you trade 2 contracts, you have to calculate twice that amount of course and a Full-in Defense would mean a position of 12 contracts.

I want to trade 2 to 3 contracts, not 12.

The Scale-In with Stop instead does not take this risk. You scale-in into as many contracts you feel comfortable with. Be it 2, be it 3 or 6. You just take a position with as many contracts you like with a predetermined risk, as you have a Stop below your whole position calculated from the average Entry price for a defined number of ticks/contract. So you know in advance what risk you will take.

The only variable is, you don’t know how many contracts you will swing in this particular trade. But so what! This does not change the Risk parameters of the trade, actually it makes them smaller, if you swing instead of 4 contracts just 2, as it means the trade did not go all 4 scale in levels against you to fill your position.

But contrary to the Defense, you always know your maximum exposure. You always know, how much contracts you will trade at the maximum and you know where you will Exit the trade.

So for my comfort level from now on, I will no longer trade the Defense, I will scale into a trade, knowing that this gives me the best entry price in these lower ranges and often range-bound markets we see today.

But I will also know that at the maximum I will trade 2 or 3 contracts depending what I trade, which is within the safety margin levels I (actually my statistics spreadsheet) consider necessary to trade without the risk of going bankrupt with 1 trade.

Relaxed trading

1 comment:

jv said...

"Scale-In into a losing trade. That’s what the Defense (see my other articles about the strategy) is doing."

In my view this so called "Defense Strategy" is actually an attempt to get out of a mistake at b/e +1 by lowering the average b/e price level as the market moves against your initial position.

I think your on the right track, having discarded the Defense, and instead looking at what is the best strategy for you to achieve your trading goals.

Here is a simple suggestion that does work pretty well for me...

Take the first 2 or 3 signals (in your case first and second signal since your trading 2 contracts), as long as the overall trade setup is still valid (has not failed).

My general strategy is to keep taking signals until the overall trade is confirmed valid or failed. If the trade setup fails I exit the entire position immediately. If the trade setup is confirmed valid ( a winner ) I hold the entire position and scale out at pre-determined profit targets.

This technique, enables me to establish a position as the trade sets up, without trying to be perfect, ie. having to find the exact high or low, instead I average in slowly (called accumulation) as the overall trade set's up (the turn forms , or new trend starts, ect).

One other comment, I think in time you will discover these types of quick initial profits (+ 5 ticks) is wasting a good trade. I think you will find that using real profit targets, based on the technical chart setup, such as a moving average line, or some price support/resistance level, or even statistically valid fixed profit targets... (or whatever your specific analysis method is). A real winning trade will always reach meaningful profit targets.

Some of your ideas/comments seem focused on how not to lose, how to get out of a loss, or how to lose less. Big profits are the true answer to overcoming losses (assuming they are small losses), and big profits come from managing the big winner correctly (maximizing the profit you extract from the winner).

One final word of clarification: I am not suggesting the "Babe Ruth" style of trading here, meaning swing for the fences on every trade. But, instead trade for singles and doubles (if that is your plan), but also plan to capture the occassional home run trade when it fall in your lap. Saying this another way, if your consistently taking 5 and 10 ticks out of 50 and 100 tick runs, then you need to evaluate your profit targets.