Scaling out of Trades: Stupidity in its finest form.
Alright gents. This is a topic to expand on trade management. And this refers to the trade management steps outlined in posts #17 and #18. The fib levels used, entries, stops movements, all are the same!!! What changes is the scaling out of the positions. Let me explain.
First let me preface this by saying that MANY people disagree with this notion of thought. This is just my view on the situation. And yea, i’m aware I told you all to scale out. What you weren’t told is that I have never scaled out of trades before last month. I was an “all-in” - “all-out” trader, and for good reason. But I thought, hey, what the heck, i’ll give it a shot. Most forex traders do it and there must be good reason for it. However, my experience has been less than satisfactory.
I was taught to trade by a brilliant mentor who NEVER scaled out of a position. He was all in or all out. This is contrary to most traders out there in the world, its contrary to many service providers like Trade the Markets, and other teach-you-to-trade companies and systems. Most advocate taking quick small profits and then “hoping for a runner”. I never bought it. My mentor always explained it to me like this (forgive the S&P500 ES math; 1pt = 50.00):
50% Win Ratio Using Two Contracts
Two ES contracts: 50% win ratio
+4pt profit target = both contracts: $400
-2pt initial stop = both contracts: ($200)
Average winning trade: $400
Average losing trade: ($200)
Average trade: $200
Ten average trades: +$2,000
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Two ES contracts: 50% win ratio
+2pt profit target = one contract: $100
+4pt profit target = one contract: $200
-2pt initial stop = both contracts: ($200)
Average winning trade: $300
Average losing trade: ($200)
Average trade: $100
Ten average trades: +$1,000
We easily see that scaling out of trades at different stages results in worse performance than the straight exit strategy.
The idea is that by scaling out you are limiting your winning profits, but still taking the full hits on failed trades. Seems strangely logical doesn’t it?
Further examples extrapolate the problem further:
Perhaps that’s just an anomaly for systems or methods with a 50% correct profit expectancy. Maybe results are far different when it comes to trading methods with a higher percentage of accuracy?
80% Win Ratio Using Two Contracts
Two ES contracts: 80% win ratio
+4pt profit target = both contracts: $400
-2pt initial stop = both contracts: ($200)
Average profit per trade: $200
Average profit x eight winning trades: $3,200
Net loss x two losing trades: ($400)
Ten average trades: +$2,800
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Two ES contracts: 80% win ratio
+2pt profit target = one contract: $100
+4pt profit target = one contract $200
-2pt initial stop = both contracts ($200)
Average profit per eight winning trades: $2,400
Net loss per two losing trade: ($400)
Ten average trades (total): +$2,000
Scaling out exit tactics with high % win achieved are nearer the straight exit results than examples in 50% accuracy methods, but still inferior. Worse yet are the standardized results for traders who are working too hard at getting out of performing trades in stages for too little net gains.
We can see that even higher % win rates don’t improve the overall profit outcome with scaling out. But what about a system with a lower win rate? Maybe thats where the profit lies…
Is there any reason to use partial-profit exits? Perhaps the true magic of this approach lies in systems or methods with less than a 50% correct profit expectancy? Care to guess how those raw data results might calculate?
Two ES contracts: 40% win ratio
+4pt profit target = both contracts: $400
-2pt initial stop = both contracts: ($200) net
Average profit per four winning trades: $1,600
Average loss per six losing trades: ($1,200)
Ten average trades (total): +$400
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Two ES contracts: 40% win ratio
+2pt profit target = one contract: $100
+4pt profit target = one contract $200
-2pt initial stop = both contracts ($200) net
Average profit per four winning trades: $1,200
Average loss per six losing trades: ($1,200)
Ten average trades (total): $0
These results are the worst by far. Why? The reason is simple: maximum profits are essential to overcoming the greater net percentage of unprofitable trades. Cutting profits short in a system or method that wins less than 50% of the time will actually accelerate losses. The worst possible scenario is a multiple-contract trading approach based on a strategy of partial profit exit levels.
So what does all of this mean? Don’t scale out!
So how does this change our approach? Not that much. I still advocate removing risk once 38% is hit and putting the stop to he 62% level, if not your actual entry point so worst case you have a spread loss (marginal).
Everything else stays the same. Take the same entry. Manage the stop the same, move them as the fib levels are hit, but don’t take that initial profit on half of the contract when 38% is hit. It feels good, but it is hurting you more than you know.
How will this change your results? Over the past month of scaling out I went back through every entry and recorded how the outcome would’ve varied using a no-scale out management. The result was an additional 220 pips of profit!!! Here is what will happen. The trades that don’t clear the 23.6% level and continue on or stop at the 38% level are now going to come back and take you out at breakeven with no profit or a tiny loss instead of a small amount of profit. BUT - As soon as you get a trade that goes onto work to a -38% target profit level or a secondary exit it MORE than makes up for any small losses you’ve accrued and then some!!!
Think about it? If we pull that one contract off at 38% and the trade goes onto work in our favor we just cut out 50% of our profits!!! But we still took on that initial risk didn’t we? We just weren’t compensated for it!
Once again, I know I am flipping on what I told you all to do, but I have spent the past month trying to convince me that this management style was correct. But I just can’t get past the hard core numbers, logic, or risk:reward that gets thrown off using this method. We’re still systematically reducing risk in the highest probability manner possible, and locking in profit rationally as it accrues, but we will be paid for the risk we have taken on.
Still doubtful? Lets put this into picture book format. Lets look at the exact trade I showed you all post #17, and #18 in the AUDUSD on the 4 Hr charts.
Image 1: The outcome of the trade based off the management I told you to do and scaling out of contracts. +205 pips right? Not bad.
Image 2: Lets not scale out! You are rewarded with an extra +141 pips of profit for a grand total of +346 vs. +205. The proof is in the pudding.
Yes, you will accrue more small losses of 2-3 pips if it fails at 38% and comes back to your entry, you will get knocked out. I actually am putting my stops at my entry price once 38% is hit. I’ve still removed virtually all the risk on the trade but if i’m right, i’m going to be paid what i’ve risked to find out. Scaling out is the poor traders psychological escape to feel like hes won, when in reality, nothing has been decided yet and hes just handicapped himself if it turns out he IS right.
Hope this helps folks. I know its a novel, but I think its a concept worth thinking about. Cheers!
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