Should You Scale Into Positions or Not?

scaling_Forex_position

Happy Friday!

This week’s question comes from RKS, who asks:

Which is better, opening a full-size position at once or scaling in gradually?

Scaling in is a great way to increase your profit potential without taking on more risk or trading more frequently.

I’ve written about this technique in the past as something called pyramiding. This is the process of strategically adding to a position as it moves in one’s favor.

But how do you decide when to scale into a position?

After all, the key to profiting from this technique is timing. If you don’t time your entries correctly, it can easily backfire on you.

The good news is that the decision-making process is relatively simple once you know what you’re looking for.

In this post, I’m going to share my process for determining whether or not you should scale in (pyramid) into a position. By the time you finish reading it, you will know when it’s advantageous to add to a position, and when one order is enough.

Ready? Let’s do this.

A Quick Note Before We Begin

There are two ways to look at the question of when you should scale into a position. The first is to assume that a full-size position is what you normally trade.

Let’s say it involves risking 2% of your account balance. So, if you were to scale into a full-size position, it would mean risking 1% on two separate positions, or 0.5% on four separate positions, and so on.

The second way to look at it is to assume we’re talking about risking a “full” position each time. Using the example above, that would involve risking 2% of your account balance on two, three or four separate occasions.

But here’s the thing…

No matter how much you’re risking each time, it’s all considered pyramiding or “scaling in”. The only thing that changes is the amount you risk, but the method is the same.

For the purpose of this post, the notion of a full-size position will remain fluid. It could be that you’re scaling up to a 2% position size or risking 2% on every position.

Either way, the goal is to find a profitable approach that works for you.

What Is the Market Telling You?

trader_listeningThe market will never stop giving you feedback, particularly one that never sleeps like Forex. Buyers and sellers give constant feedback about support and resistance, trends, and the trades you take.

The question is, are you listening?

Not every situation will be conducive to pyramiding. In fact, at least half of the trades you take won’t allow for a second or third position.

Of course, it all depends on your requirements to open a position in the first place. If you have a 5R minimum where the reward is at least five times greater than the risk, you’re likely to have more pyramiding opportunities than most.

The point is, every situation is different. It’s your job to assess the setup in front of you along with overall market conditions and make a judgment call.

Take the two scenarios below. In the case of the USDCAD, there wasn’t a favorable opportunity to add to a position because the market was range-bound.

USDCAD_range

You should always have a final target defined before placing a trade. The distance between your entry and this target will often decide whether or not you’ll be able to add multiple legs to the position.

Another consideration is the expected duration of the trade. If you suspect the market to hit your target within the next couple of days, there may not be an opportunity to add a second or third position.

Notice that with the USDCAD daily chart, there was only room for one entry (leg). Also, each retest of support and resistance only took a few days, which didn’t leave us with enough time to scale in.

Last but not least, the market was sideways. There was no bullish or bearish momentum to warrant a second or third entry.

Now, let’s take a look at the EURUSD daily chart below. This is an excellent example of a situation where pyramiding makes sense.

EURUSD_trend

It’s easy to determine that this is a trend we want to scale into after the fact. But what about when it was unfolding?

How could we have known this was a market worthy of pyramiding?

One word: momentum.

When you see a market trending like the EURUSD chart above, it’s time to at least consider scaling in.

The one caveat is that the market must be respecting key levels just as the single currency was in the above example.

Every setup is different, but if you use the expected duration of the trade and the distance to the final target as metrics, deciding when to scale in becomes rather straightforward.

Never Add to a Losing Position

losing_positionAs you can see, the idea of scaling in or pyramiding can be an extremely profitable way to maximize profits.

If you still aren’t sold on the concept or need some help with the technique, feel free to visit this post.

However, it only works with winning trades. Sure, you might get lucky and come out ahead by adding to a losing position, but the odds aren’t in your favor.

You want to compound winning trades, not losing ones. The latter will only serve to eat away at your trading account that much faster.

Think of it this way: a market that moves in your favor is telling you that your assessment was at least partially correct.

If you make the mistake of adding to a losing trade, you’re ignoring what the market is telling you.

Remember, the market is always giving you feedback. It’s your job to stop, listen, and react accordingly.

Always Trail Your Stop Loss

Allow me to revisit the question that inspired this post for a moment.

The trader asked whether it’s better to open a full-size position at once or scale in gradually. Technically, you can have both.

Assume for a moment that you opened a long position in the EURUSD based on the uptrend we studied above. It’s a full-size position and your total risk is 2% of your account balance.

Now, what if you scaled into the trade by adding two more positions of equal size on the way up? Keep in mind that you are only adding once the pair breaks above key resistance levels.

That sounds like a lot of risk until you consider that the market is already moving in your favor. Furthermore, you are trailing your stop loss as the EURUSD closes above key levels.

Doing this allows you to enter and scale in with full-size positions without incurring excessive losses should the market turn against you. In fact, you will quickly find yourself in a no-lose situation.

Alternatively, you could choose to risk 1% or even 0.5% of your account balance with each position. What’s important is that you trail your stop loss to mitigate the potential for loss and also lock in profit along the way.

The decision of how much you risk is yours alone. It all depends on your tolerance for risk and style of trading.

Find a Method That Works Best for You

This post is a collection of ideas to get you pointed in the right direction. Whether you choose to scale into positions and the methods you employ if you do so are entirely up to you.

There is a truth about trading successfully that outranks any strategy, method or approach. It’s something that is essential to acknowledge if you want to become profitable.

That truth is that you must find a style of trading that suits your personality. This style affects everything, from the currency pairs you trade to the entry and exit techniques you employ.

Deciding whether to scale into positions, and when to do so, is no different.

Final Words

Knowing if you should add to a winning position is never a black or white decision. No two setups are the same, which means each one has a unique set of variables that must be considered.

It’s also a very personal decision. I have found pyramiding to be an extremely lucrative way of maximizing profits, but that doesn’t mean it will work for you.

The best way to determine if it’s right for you is to experiment. Just remember that not every setup is a candidate for scaling into a position. It comes down to factors like momentum, key levels, and expected duration of the trade.

One rule that isn’t up for debate, at least not in my opinion, is that you should never add to a losing position. Doing so can get you in a lot of trouble. It also challenges the very premise of pyramiding, which is to increase your size once the market proves you right.

Your Turn: Ask Justin Anything

I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.

To do that, I need your help.

Here’s what you can do to get involved and have your question answered in next week’s post:

  1. Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
  2. Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.
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