Scaling into positions – a better approach?

We look at how slowly building up a position can provide a less stressful and more effective method.

Chart
Source: Bloomberg

‘Fools rush in where angels fear to tread’. So runs the old saying, but it has a place in trading too. In looking at ways they can profit from the market, traders often assume that they have to go ‘all in’ on a position, putting on a large trade straight away in order to reap the benefits. Too often, however, they end up reaping only a large loss. Just as bad is the risk that they get too nervous when the position moves in their favour, and close out a winning trade too early.

A second adage is, ‘slow and steady wins the race’. This is where the tactic of ‘scaling into positions’ comes in handy. Instead of, for example, buying the FTSE 100 at £10 per point, a trader would look to test the water first with a £2 per point position, and then add to it if the trade moved in his favour.

A position can gradually be built up in this way without the need to commit entirely. Other trades can then be opened using the margin that would have been used on the £10 position, with the trader probing for winners by reducing his risk on each trade. Such a method allows for wider stops too, helping to reduce the risk of being stopped out by a whipsaw move.

Even if three or four of the five trades placed go wrong, the losses will be small, but the winning trade can be added to, thus increasing profits. ‘Never reinforce failure’ is a famous military adage, but traders would do well to remember it. After all, trading is about testing ideas against a market, and allowing the successes to run while being ruthless with the losers.

The rule when adding to a trade is to approach it as if it were an entirely new trade. Thus, traders look for a replication of the conditions that caused them to trade the asset in the first place.

In this way, traders will find it easier to control that most difficult element of trading, namely their own emotions. When going ‘all in’ with a trade, nerves run high and there is a hope that the trade will immediately become successful. Smaller positions mean that emotions are reduced and traders will approach trades with a more neutral mindset.

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