Sunday, September 4, 2011

Why and how I scale out of trades on ES

One of the things that is part of my own trading style is scaling out, some traders will prefer to go full size until their final target, OK, nothing wrong with that, but in my experience, lots of trades I take go in my favor for 2 or 3 ES points (Emini SP500) just to come back and hit my STOP loss order, so I learned to scale out as a rule.

I consider scaling out as "an insurance" I pay for a calm state of mind and also a way to protect my capital.

But, don't be mistaken, in my strategy, I play much bigger than I "normally" would with an account as big as the one I trade, let me give you an example to make that thought clearer.

If you have an account of say US$ 50,000, as a conservative trader, you should risk no more than 2 or 3% on each trade, that would be: US$ 1,000 to max US$ 1,500, considering your max STOP will be of 3 ES points (or 12 ticks), the maximum size you'd be allowed to trade would be: 10 lots, if you got stopped out you'd lose US$ 1,500 + "commish". OK.

How would I trade an account that big?

I would set my first target at US$ 60,000 (a US$ 10,000 profit), to reach that target with 10 lots I would need to make 20 ES points on full size, good.

When I reach that target I'd increase my bet size to 16 lots, because now I'd be risking only the profits I already have, and I would have to be wrong 12 times in a row to give all my profits back, something very unlikely when using the system I do that gives me a win rate of over 70%.

So, my next target now would be say: US$ 75.000, I would need to make less than 20 points on full size to reach that new target this time, and so on until I can trade 1,000 lots! ...or more. :-) But that's not the point here, I'll talk about that in a next post...

What we are interested in here is looking how I do the scaling out in my trades on ES.

Usually I'll scale out half at +1 ES point, that already drastically decreases the risk I'm taking to 1/3 only, but if market conditions continue in the weeks ahead with the same kind of volatility it had in August, I can easily go for +2 points for the first half off, see the example below on how that would work:

Trade example: (20 lots) (not considering commish here)

Long 1170 - STOP 1167 - Full size initial risk: US$ 3,000

Scale out half (10 lots off) at 1172, +2 points = +US$ 1,000

Now holding only half position with same STOP at 1167, risk decreased to: US$ 500 (or 1/2 ES point (2 ticks) on full size)

Second scale out at +3 points, only 1/4 off this time or 5 lots at 1173, +US$ 750

Now you'd have a profit even if you got stopped out on last 1/4, total profit so far = US$ 1,750

STOP still at 1167 and if stopped out you would be out of the trade with +US$ 1,000 in profits, not bad.

Now you'll trail the last 5 lots and only leave when stopped out, so let's suppose you made another +8 points = US$ 2,000, that would give a total of: US$ 3,750 on the trade, or +3.75 ES points on full size.

"At the end of the day, the most important thing is how good are you at risk control. Ninety-percent of any great trader is going to be the risk control." by Paul Tudor Jones

Best of luck in your trading, trade well.

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