Part I. Scaling of Position

Commander in Pips: Since we’ve discussed the basic rules of money management and leverage application - you can start to trade with them and I have sufficient confidence that you will not blow out your trading account. We know how to estimate the value of your position, its link with risk management – now let’s add some flexibility to this. Probably, if you just have started to trade, you may stand without any scaling of your positions, but a bit later you may try to apply it.

The basic rules of money management and leverage application - Forex School

Pipruit: And what is scaling of a position?

Commander in Pips: Scaling means gradual increasing or decreasing of the value of your initial position in the process of trading. This could give you a lot of advantages – increased profit, probability to get it, lock in some profit or even reduce risk. But to properly apply that issue – you have to follow money management rules. If you will blindly add to your position without any reasons and limitations – be ready for huge blow out of your account some day. Our task in this chapter is to discuss how to apply scaling.

Initially it is better to foresee scaling and write it down in your trading plan at some price level. This will let you to do this reasonably and calculate risks ahead of scaling, so you will not need to think about risk in the process of trading. This is just safer.

What is scaling of a position? - Forex School

Pipruit: And why do we need it? I feel quite comfortable with my initial position…

Commander in Pips: That’s good. I do not disagree with you. This is just an option – you can use it, you can ignore it. But let’s discuss it first, and then you will be able to make reasonable choice, ok?

Pipruit: Ok, ok – what is so fascinating about scaling?

Commander in Pips: Well, scaling has some advantages. First, if you add to your profitable position and the market continues to move in your favor – I suppose you like it, don’t you?

Pipruit: You bet!

Commander in Pips: Second, scaling could let you to lock in profits. As we discussed already – our task is to skew probability in our favor in any trade. So we have to make profit. With applying a trailing stop-loss order after breakeven, separating your total trading lot into some parts will allow you to achieve this goal. Applying scaling out in such a manner as this will allow you to finish some trades at breakeven or even with some profit, while you could finish them even with some loss without scaling. With other trades scaling will allow you to get more profit than if you applied just a single order at the beginning of the trade.

And finally, is third big advantage – scaling will help you to get in. Has it ever happened to you, that your analysis was perfect except entry point – the market has not reached it for some pips and then starts move according to your analysis?

Pipruit: Can a duck swim?

Commander in Pips: I thought as much. Very often (if not to say always) we have 2-3 levels, where we can enter, and reaching of them will not cancel our context. Another way is when the entry area is not just a precise price but more of a range, especially on longer time frames. So, scaling in will let you wisely enter the trade – so if you even will not enter at the perfect area, you will take part in the trade and make necessary profits.

Pipruit: I tell you what? Go ahead – I probably would like to hear more about scaling…

Commander in Pips: Heh, maybe you want to hear something about the drawbacks of scaling first, don’t you?

Pipruit: Hm, are there any of them?

Commander in Pips: Yes. The first one is if you have scaled in and the market has reversed against you. If you’ve done it improperly it will increase your risk. That’s why we’ve said that money management is the first, while all other stuff is second. Applying scaling by gut feeling will lead to fiscal devastation. The second negative moment is not so crucial, but you can feel some upset if this will happen with you. This is scaling out after which the market continues to move in your favor, or even speeds up significantly after your partial exit. But this upset usually hits undisciplined traders, who trade without specification of targets. You will not feel any upset if this scaling out was planned by your trading plan. I tell you more – this even gives you positive feeling, because you will fulfill your trading plan at 100%.

Pipruit: Ok, let’s see what scaling the beast is.

Scaling out

Commander in Pips: Ok, the first way is a pleasant one – scaling out. I call it “pleasant” since it includes profit taking. About the “scaling in” procedure we will talk a bit later. Actually we’ve spoken about this way in details in harmonic patterns trading section. Also this approach clearly described in L. Jouflas and L. Pesavento book – “Trade what you see”. So, if you will need more clarification – be my guest. Although they apply such a way of scaling to harmonic pattern – it could be applied to any approach. Harmonic pattern is just on that trigger your in. If you apply another way to enter – this is no problem, you may apply the same “scaling out” procedure. So, let’s see how it works.

The statistical foundation for scaling out is to increase the probability of getting profit and stay with the profit/no loss situation with as much probability as possible. Initially at the stage of your trading plan creation you have to assume partial scaling out of your position. There are two goals that assume scaling out:

1. Move your trade to breakeven reasonably as soon as possible;

2. As first goal been achieved – get profit.

So, in a way of example that we will show, you gradually move the odds into your favor. Our task in any trade is to not get as much profit as we can anyway (although it looks attractive), but to get as much probability to get profit or stay at breakeven as we can. On first view it might be seen as curious, but trading is a huge number of trades. If you follow the maximum profit in any trade and do not move probability in your favor – you probably will catch some of those big trades, but will lose in many others.

When your probability to success becomes much greater in every trade but profit itself becomes a bit smaller – then you will get a better overall result. I will not even talk about the psychological component. The simple example could be as follows: What is better to get $1500 profit and then take a loss $250 in 5 trades in a row later or to get $150$ profit in 4 trades in a row and 1 loss at $100? Is the result the same? I think the choice is obvious. Ok, that’s enough blah-blah-blah – let’s pass directly to an example. That is our butterfly “sell” that we’ve used already but for a bit different purposes.

Now let’s discuss a scaling out example.

Chart #1 | EUR/USD 60-min Butterfly “Sell” trading

EUR/USD 60-min Butterfly “Sell” trading - Forex School

Let’s suppose your trading plan assumes of trading this pattern. You do not know initially will it be 1.27 Butterfly or 1.618, so you’ve decided to enter from 1.27 area. According to trading rules, your stop should be at “invalidation point” that is 1.618 level + hourly harmonic number 20 pips, that couldn’t be passed just occasionally. Let’s suppose that your account assets are 10,000 USD and your money management rule is 1.0% in any trade. What lot should you enter from 1.3543 level and stop at 1.3590?

Pipruit: Well, 1.5%*10,000 = $150. Then $150/(1.3590-1.3543) ~30,000USD or 0.3 standard lot.

Commander in Pips: Very good. We’ve entered with 0.3 standard lot from 1.3543. What we do next is to skew probability in our favor. First, we have to turn our trade in breakeven way and lock in a minimum profit.

Now we see, how price drops to 1.3496 - 50% support of whole butterfly move – from 1.3443 to 1.3550 high. You do not know what will happen next. You see that move down was nice and there are a lot of chances that it will continue, but you do not know for sure. At the same time, the market has passed 50 pips in your favor and shows some hint on retracement at 50% support.

- You close 50% of your position. Profit 15,000*(1.3543-1.3496) = $70.5

- You move the stop at second leg at breakeven – 1.3543.

It always makes sense to take some chips off the table in such manner. Just look what we’ve just done – you will get some profit and your position now is riskless. You can just lie back and watch the movie…

Trading is continuing…

Later you see that market has hit 0.786 support. All later action will depend on trader’s experience. Newbie trader probably will close rest of position and get:
- 15,000*(1.3543-1.3466) = $115.5 profit. Total profit is 115.5+70.5 = $186.

Another way, if your broker allows you to do this – you may close 25 % or, say 0.08 lot and hold the other until the ultimate target at 1.3377.

In fact this will not change the overall picture. Probably an experienced trader will get a bit more profit, while a newbie a bit less, but profit is profit. Pay attention to how probability was skewed by our action in our favor right after reaching of the nearest target at 1.3496. Here you shift your trade to 100% profitable one, since you already have earned 70 bucks. Second, you have turned the rest of it into a riskless position. That is scaling out application.

Pipruit: Could I apply different stop management? For instance, could I not to take any profit at 50%, but just move to breakeven, since the market has passed harmonic number (40 pips) in my favor that should not been happened just occasionally?

Commander in Pips: Well, you can do this. This will reduce your risk, but will not increase the probability to get profit. If market will return right back – you will not earn anything. And your job is to make profit. Trading is a marathon, and the winners are those who run long distances at the same speed, not the sprinters, who run fast initially but then stop. The “same speed” means gradual profit in every trade. As soon as you can take a reasonable part of it – do it. That we’ve done in our example on 50% support level. So we’ve accomplished our first goal – we will end this trade with profit anyway.

I see that you do not feel confident enough with that issue – taking a part of profit. Here is another example for you on the weekly time frame:

Chart #2 | EUR/USD Weekly
Looks like a Gartley “222” buy pattern from 1.2870-1.4925 swing. - Forex School

I will not describe all the details here. Let’s assume that you intend to enter long, since weekly upward momentum was really strong. In October you see that market is approaching an Agreement area 0.618 minor support level at 1.3214m and 1.618 downward extension from initial AB-CD pattern of retracement from the 1.4925 high. This is also looks like a Gartley “222” buy pattern from 1.2870-1.4925 swing. Let’s suppose that you’ve entered long somewhere above 0.618 support and placed a stop below the most recent swing low 1.2870. Your initial target is the 0.618 extension from the most recent swing up at 1.4412. You think that the market should reach at least this extension, since momentum up was solid. What has happened later – you can see on the chart. You will get absolutely different result if you took some profit or not. Also just imagine that you have ended potentially profitable trade on weekly time frame without any profit. And have spent approximately 3 months on it. What a pitiful perspective…

Pipruit: Pitiful perspective? This is an absolute nightmare!

Commander in Pips: Oh, I’ve got it! You need to see big numbers to feel it absolutely.

When you see the possibility to miss 800+ pips profit – that has some impact!

Pipruit: Ok, ok. I see the difference with smaller numbers too… What’s about scaling in?

Commander in Pips: Right. This is a bit tougher process that demands more responsibility and discipline, since you are increasing your position – hence adding more risk.

Comments

rajesh bhujbal

11 years ago,

Registered user

Hi COMMANDER ,

I know that you dont have your legs...!!!!!

you must have lost them in some battle .....!!!

i just looked at your photograph....

(LOOK AT SECOND ANIMATED IMAGE ON THIS PAGE, COMMANDER DOESNT HAVE ANY LEGS...)

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Part I. Scaling of Position

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