Now on to the fun stuff. If you catch a great trending move, scaling into it is a great trade adjustment to increase your max profit.
Again, just like Peter Parker, with greater reward, there is great risk, so there are rules to follow to safely add to open position. Let’s go over those rules.
Rules to safely add to winning positions:
- Pre-determine levels entry for additional units.
- Calculate your risk with the additional units added.
- Trail stop loss to keep growing position within comfortable risk parameters.
To explain this strategy a little better, let’s go through a simple trade example…shall we????
We have Tom the “trend trader” closely watching EUR/USD, and after a bit of consolidation he thinks traders will push the pair higher which leads him to plan to on buying some euros against the U.S. dollar at 1.2700.
First, he sees that recent consolidation never really traded below 1.2650, so he decides his stop will be below that level at 1.2600.
Tom also thinks that because it is a psychologically significant resistant level, 1.3000 would be a great level to take profits because a rally may stall there.
With a 100 pip stop and a 300 pip profit target, his risk-to-reward ratio is 1:3. Pretty awesome right?
He usually only risks 2% of his account per trade, but this time he’s really confident with this trade and with the great risk-to-reward ratio, he decides he will add more if the market moves in his favor.
He decides that he will add more units every 100 pips and trail his stop 100 pips. Because he plans on adding more units, he decides to start with an initial risk of 1%.
With a starting account balance of $10,000, Tom’s initial risk will be $100 ($10,000 x 0.01).
With a 100 pip stop and $100 risk, he has determined his initial position size to be 10,000 units (position sizes can be calculated with our position sizing calculator), he will add 10,000 units every 100 pips, and trail his stop every 100 pips.
Let’s take a step-by-step look at the change in risk-to-reward with each addition.
This simplified example shows the basic technique of how to safely add to winning positions and how effective it can be to maximizing your profits.
Now before you go pressing up every winning position you have, you have to be aware that adding to winning positions may not be the best tool for every market environment or situation.
In general, scaling into winning positions is best suited for trending markets or strong intraday moves.
Because you are adding to a position as it goes your way, your average opening price moves in the direction of the move as well. What this means is that if the market pulls back against you after you have added, it doesn’t have to move as far to get your trade into negative territory.
Also, you should know that scaling into winning positions in range bound markets or periods of low liquidity leaves you open to being stopped out often.
Lastly, by adding to your position, you are also using up any available margin. This eats up into margin that can be used for other trades! You have been warned!!