Scaling out vs staying fully invested

I've had my brain on fire for the last 3 weeks over this problem, as I've started to see my gains in % terms for my bank and NOT in total pips, and it has changed my outlook, and goes against what I've been told to do in order to protect profit. So I'd like to explain my conundrum, and by doing so it would be great to get some thoughts on this, and at the very least, it might help clarify certain points with other traders.

What I've always been told is-scale out a predefined profit level-for me, it's the 1/1 ratio, so level 1 is 25 pips profit-I'm out by 1 lot.

Say my maximum risk is 25 pips (including spread), and this represents 1% of my account. Say my account is 100k. My risk is 1000. 1000/25 = £40 per point.


Here's where it gets complicated. Is it better to scale out with reduced lot size at different profit levels i.e. 3 lots=£13.33 each, or is it better to just stay in with the £40 per point?

By using percentages instead of pip counts, I've come to the conclusion that it's better to use just one lot and to stay in. You might not lock in profits as often as you like, but when you're in the right direction on a trade, because you're still fully leveraged in the trade, an increase of just 5 pips is worth 0.2%.
If you've scaled out, you're diluting your profit potential. For example, it's always nice to get one of those days when you make 100 points, but what does that really mean if you've scaled out?

If I have take profit points at 25/50/100 pips on 13.33 per point, then I've made :
25 pips = 33.25
50 pips = 666.5
100 pips = 1,333

Total = 2332.75 (2.3% of account)

If I had decided to take profit at 50 pips on the full lot size of £40, then I would have £2000 (2% of account)

So I would have made less at £40 per point BUT it is not a significant amount less.
And the second important point is-how many times can I really expect the price to go 100 pips?
For an intraday system that I use, that's a fairly big move to have managed to stay in without prices retracing/playing around for hours, and it would most likely need the US session (I trade the London session primarily) to go my way as well, which is by no means guaranteed.

If I hit 25 points, with just one lot at £40, I have made 1% profit-a 1/1 risk reward scenario. IF I STAY IN, then the price doesn't have to go too far in my direction for me to start making serious profit. If it gets to 40 points, then I've made a 1.6% profit. 50 points then I'm at 2%.

But if I've scaled out, then these profits are MASSIVELY diluted, and I need the price to go a lot further for me to reach similar profit levels, and the probability of this happening is a lot less due to the levels that need to be reached.

I have no idea if I've explained that clearly, I hope that I have, and I hope to get some debate on the subject.

I'm aware that it obviously doesn't involve price retracing etc, but really, if all I have to do is hit 40 points for 1.6 % profit by not scaling out, then surely the answer is simple or have i got this arse backwards?
Eur/USD today is a good example, I was in for 2 lots-took profit at 23.8 pips and 44.1 pips. Assuming my maximum risk and bank size, profits=

1st lot = 476 profit
2nd lot= 882 profit
Total = 1358

Or if I just waited for 35 pips with one full lot, I would have made £1400.
And price going 35 pips is more likely than it going 50+.

Btw, yes my profit targets were a bit lower than 1/1 ratio, the speed of the movement took me by surprise

My thoughts.... you're going to have a debate on both sides of this. Everyone is different.

Some will say that you don't want to cross the finish line with only two wheels left on your car. Others will repeat the myth..... always scale out. And scale out at predetermined pip counts as well !! I mean, what about making each decision based on what is happening right now ??

Well, you gotta do what works for you.

I think that newer traders could benefit from scaling out because it can help with the psychology of having to face a pullback.

Other traders may have a well defined method that includes scaling out as a necessary part of their plan.

Bottom line ?? Don't be afraid to toss the standard advice, that scaling out is the only right way.

And.... some very successful traders that I know always hold the full trade until its conclusion.

Your choice.

I too have some work to do on this subject as I frequently take partial profits / scale out only to see price give me another 20 or more pips, so I'll think about this later....first the ZEW data.....mmmm, I wonder if its a Sell the Rumour, Buy the News type of day.....

Thanks for the advice.
As for today, I'm wondering if there was a leak of some kind today as prices took off at an odd time with no definable reason (other than being more sellers than buyers of course).
Islander, it's a real headache. When you see price move 100 pips you want to be part of it, but by scaling out, while you think you're staying part of it (technicaly you are), it's at a profit level that is less advantageous. At least I think it is.

Price, I agree, a debate/exchange of thoughts is what I'm after. I've gone from scaling out to wondering whether it's worth it, and by thinking in % terms of profit level in relation to my bank, it seems to have tipped in favour of not scaling out.
I think a point that I didn't make is that it's very nice on a psychological level to have one lot out of 3 left in the trade, and then to take profit at 100 pips. It makes you feel like a Master of the Universe. But by scaling out, you're misreading the profits that this approach gives you. The trader is seduced by that big figure of 90/100 pips (woohoo!) but it doesn't tell the whole story.
Price, am I right in thinking that you also agree with not scaling out?
I think you're right, it does help psychologically/mentally to scale out and lock in profits, that is the trade off isn't it.
Exiting 50% of my position at 25 pips represents a 0.5% profit which is a nice thing to walk away with if price reverses.

I should add I don't scale out/TP at fixed levels etc e.g. if there's a double top and I'm long then I'll be looking at that level first.

The reason why is covered in the following links. I had the same question 2 years ago and once I'd read the answers I never looked back.

http://www.forexfactory.com/showthread.php?t=12273

Thanks Peter, will have a good read through.
Funnily enough, have a mate doing a Maths Phd and was going to ask him to look into this. Problem is he isn't a trader so wasn't sure if it would be too hard to explain to him. On reflection, it probably wouldn't have been too hard as I'm pretty sure he's not as dim as me.

OK - before I go out for a couple of hours, here are my thoughts on the Euro this morning - as I dont usually trade it and so I missed a great opportunity....

If you look at my posts in this thread.....http://www.forexfactory.com/showthre...98028&page=314 you'll soon see that I use pivots and sweet spots plus Lower Highs and Higher Lows and that I start trading about half an hour before the Frankfurt Open.

Today was classic, with three potential short entries off Lower Highs, the last two using the Daily Pivot as resistance.

Many traders believe that Euro data is widely leaked and today was no exception and it only took The Frankfurters ten minutes to start selling.

Once a move like this has started, I'll normally be looking to TP around the S1, S2 and S3 levels.....however, the move was very strong as shown by the distance price kept away from the faster MA, so I think that I would have pulled my TP at the S1 level and looked for the S2.

Off the S2, the bounce to the 575 sweet spot / still falling 10 ema provided another opportunity to sell with the fall finally stopping just above S3 as the news hit.

By this time I was watching and so bought the Higher Low at the green arrow and set my TP for the 550 level - I'm against the trend, so its best not to be greedy. I pocketed a nice 20 pips...

Later I'll give some thought to your main question.....BFN

Wow... great info there Peter!

Cheers!

Price has a good point. I would add to it the following: newer traders tend to start always by the lowest TFs, that's why they feel safer with scaling out (they use tight SL, thay want low market exposure...).

magnumfreak, on another thread said something interesting to all:


ATM I'm working hard to have the guts to hang on... 100% in or 100% out, but it's very hard, psychologically speaking... I'll get there...

Bootsyjam - a great thread, and you pose questions which are not asked often enough in the trading world!

My simple 2 cents: Fully understanding the CAPABILITY of your method/system answers the question.. The question then becomes how to fully understand that capability (a different thread required here)

A very common assumption I see in the trading world (which frankly annoys me) is that in any good "system" there is an initial take profit target for part of the contracts, the stop loss is moved to break even, and the remaining contracts are left to run with a trailing stop just in case a big winner is at hand.... A totally BS assumption, unless it has been properly tested and proven to be valid!!! The translation of this approach is akin to:

"I have not properly tested my method and therefore do not understand the true capability of my system, so I'll therefore establish a neutral position as quickly as possible and let some of the trade run and hope for the best.... this is not only a logical way to trade, but is also good for my pyschology..." UTTER CRAP!!! (unless PROPERLY tested against other scenarios and proven to be correct)

Back to my original question - what is the capability of the system(s) at hand? When I found the answer to that question in my own trading, it lead me to place trades with one proft target and one stop loss, and to walk away and accept the outcome... More familiar to most readers of this forum (I think?) would be a scenario applying to riding a trend (different to what I do), which might lead traders to scale into a trade with the trend, rather than scale out of it - the latter, illogically in my opinion, being the more prevalent assumption in the trading world, which I suggest only helps to dilute potential profits rather quickly, but somehow makes people 'feel good' about what they are doing...

Two excellent books on trading have opposing views on this.

Van Tharp's "Trade Your Way to Financial Freedom" actually discourages scaling out. It's an excellent book on developing and analyzing trading systems.

Mark Douglas' "Trading in the Zone" encourages the reader to scale out in thirds as a means to controlling emotions during a trade. You ring the cash register and tighten the stop, yet leave some portion to capture a potential larger move.

Both authors' viewpoints have merit and are worth reading (I own both books).

What do I do? I generally scale out by 1/2 and move the stop to breakeven after my initial risk is covered (i.e. entry-stoploss). Is it satisfactory? I'm finding myself routinely being shaken out of the second half of my trades and not catching a larger move. I'm pretty sure this is due to moving the stop too aggressively out of fear of losing money. Also, I'm occasionally stopped out for the full initial size, which really hurts.

I do not trade for a living and am still finding my way.

Well, I believe that scaling out is a bit of a myth.
I think it can have its place, if it is within a well defined trading plan, however...

One problem I see is, if you're scaling out the winners and letting the losers run full boat, that doesn't seem like the best way to go.

A lot of times, scaling out is based on fear, just like killing the winners too quickly. I don't think that's a good idea.

Peter has a well written thread on the subject. (see the link some posts back) I think I'll take another look at that as well.

It's a personal thing, and can get quite complicated, mathematically / psychologically, etc. Good luck in your studies, and keep us posted !!

*OK a couple more thoughts..... you mentioned a math phd to help with this. I'm not convinced that a 'math guy' without trading experience would be able to crack this code. You need to take into account price action and current market conditions. These are ever changing.

Example: Should you exit half your position at S1??
Well that depends. If it's anything like the Euro run-down a couple of hours ago.... then maybe not. That was a fast enough move that holding for S2 would be justified.

Other days.... I love exiting PoundYen at S1. So, you see, it all becomes another big part of trading decisions that are constantly being made.

Here's my 2 cents worth. If scaling out is such a great idea for profitable trades, why don't you scale out of losing trades? Stands to reason that if it is good for one it should be good for the other right?

Islander, I agree r.e. Daily Pivots, I always trade in the same direction as them. Never 100% perfect but then what is?
Regarding Eur/usd today, the logical TP level would have been the 1.4580 area where there is a double bottom which normally can act as a reversal point. Although this time the price bombed straight through. Doh!



Stevegee, I've also read Trading in the Zone and it has helped me massively with my mental approach. However I'm (clearly) starting to move towards the idea that the maths is wrong on scaling out. I think it's a pyschological trick that appears to make mathematical sense, but in actual fact it is just a psychological trick with no mathematical sense.

I've looked at the idea of scaling into a position but am not sure this would work so well on short term trading where reversals are more likely to occur.

Housetrader, I do find this quote very interesting so thanks for posting:
"I used to think the scaling out method was best for profit until I thought about the fact that I do not scale out of a losing trade why should I scale out of a winning trade?" I need to do some testing on scaling out of a losing trade as I was also taught that this was a good idea.

Price, you're right, I think scaling out when in profit is based on fear. My system works pretty well, and the amount if times I headbutt the desk because prices have continued to move after my TP levels are hit are too many to count.

Peterfm-thanks for the link. Your conclusion is that you're now better at recognising TP levels/reversal points, and you're now more able to sit on your hands and stay in a position?

Hedginghog-that's the crux isn't it, how effective is the system (pretty good I think as it happens). When I have full confidence in the capability of my system (which i pretty much do already although clearly not enough) then I will no longer be slamming my fingers in the desk drawer in order to keep them away from the mouse button.

In normal market conditions, yes.

Unfortunately, I don't consider the lead up to Christmas and the next few weeks normal. I still trade the same but with much reduced position sizing.

Scaling out will give you less return but a smoother equity curve.

Speaking of the "maths" (we Americans don't say this but say "mathematics" or "statistics" LOL), check out twoblink's threads. He claims that the maths positively *don't* support scaling in (i.e. adding to a losing position) but do support reverse scaling or pyramiding (i.e. systematically adding to a winning position). Twoblink not only proposes a method for increasing position size on winners, but also reducing risk as you add. It seems counter-intuitive, but the math works out.

Pascal's Triangle as MM
Optimized Risk vs Reward Equation

Twoblink is somewhat academic, but his analyses are always well thought-out.

Thanks stevegee, I looked at that before.
It's definitely interesting, but I think the part that is perhaps glossed over is when it's mentioned that "Assuming the market is up, at another predetermined point, I buy another 1.5 lots."

The predetermined points are the issue, you don't know the market will continue higher, it's a major assumption to enter at a higher price than the original entry. Of course if it's more longterm trading then the chances of reversal are (theoretically at least) smaller.

Aicccia-short and straight to the point, and may have provided the answer!
It depends with what I can live with, taking profits less often but at higher levels, or taking profit more often but at lower levels. Dangnabbit!

Peterfm-agree r.e. lot size, I'm the same, although it think it is harder for longer term traders such as yourself with getting whipsawed thanks to any real momentum.

Something to consider, which is something that has worked for me, is scaling into your position.

Let's say you intend to risk 1% on a given trade while trading off the hourly chart. Break your trade up into 4, so that on the first signal candle you risk .25%. If after the first hour the trade has gone your way, add another trade = .25% risk. Continue in this manner until you are fully loaded. Exit at your predetermined level or trailing stop.

You will find that on most trades that go against you there will be less on the line, while you have "loaded the boat" on trades that go your way.

Hope this is helpful.

Happy trading,
Art

I'm still not convinced of the mathematical viability of scaling into positions when trading short term ( I am in and out of trades from 5 mins to 2 hours, dependent on if SL or TP levels are hit).
Trends are less strong and more apt to reverse in the short term trading environment. However I'll research the scaling in, but do it in % terms of how much I make. By thinking in % terms, I've got to this level of understanding, so it makes sense to continue on this path to see maximum gain potential.
Scaling in sounds good, but a taking a .25% risk as a final position in a move that has already gone 10-40 pips my way doesn't sound like a good idea. In fact it sounds like buying too late/nearer the top?

So the options, for me at least, are to stay locked in at 100%, win less often but win bigger when I get a 'runner'.
Or to exit 50% at a lower level to lock in profits and to let the remainder run.
Or to mix the two together depending on how strong I feel the set up/price action is.

If anyone cares, I think I'll do the last two, with a bias on taking profit off the table early. Aicccia has made a good point, it's a better equity curve to take the smaller profits off the table early. For me, that profit level is 0.5% of my bank, and it ensures that my profits tick along nicely with the occasional big win to help.


It is also better psychologically for me, but perhaps not mathematically, to take profits early. We're all human, and if I have a few days of being up 20/30 points, not taking profits and having prices reverse (hey it happens), then I would be in danger of losing my mental equilibrium which is, in it's own way, vital to trading.

I've also thought of two other reasons why. If, using the example above, I take profits early at 25-30 points, which represents 0.5% of my bank, I will have built up, for arguments sake, 1.5 % on 3 trades that have then reversed. It's not a lot, but if I'm constantly compounding and increasing my bet size in accordance to my bank growing larger then it should help somewhat in bridging the gap between the performance of the two profit taking techniques.

Second of all, there is the hidden, and possibly unmeasurable advantage of taking 50% of my position off the table when prices do reverse, and I then incur a loss.
If I was still in 100%, then my losses would be larger. They wouldn't be huge as Stop levels would be raised higher in accordance with the price move in my direction. But the losses would still be larger thanks to the fact that I would still be in 100% combined with the fact that I would also have missed out on banking 0.5% profit. So there is a double whammy really.
For example, if I lose 0.25% of my bank on one trade while I've stayed 100% committed and not taken profit off the table when I had the chance (0.5% of my bank), then the actual difference is -0.625% in relative performance between the two profit taking systems (remembering that I still have 50% of the trade which is 0.5% of my bank still in the trade so it's -0.125% in this example of the SL level). I hope that makes sense?

Thanks very much to all the posters for their guidance. It has helped me view my strengths and weaknesses in a new light, and made me fel a lot more comfortable with what I'm doing. Hope it has helped others as well.
Happy Xmas and happy trading