As mentioned earlier, scaling out has the obvious benefit of reducing your risk as you are taking away exposure to the market…whether you are in a winning or losing position.
When used with trailing stops, there is also the benefit of locking in profits and creating a “nearly” risk-free trade. We’ll go through a trade example to show you how this can be done.
Scaling Out Example:
Let’s say you have a $10,000 account and you shorted 10k units of EUR/USD at 1.3000. You placed your stop at 1.3100 and your profit target is 300 pips below your entry at 1.2700.
With 10k units of EUR/USD (pip value of this position is $1) and a stop of 100 pips, your total risk is $100, or 1% of your account.
A few days later, the EUR/USD has moved lower to 1.2900, or 100 pips in your favor. This means you have a total profit of $100, or 1% gain.
All of a sudden, the Fed releases dovish comments that may weaken the USD in the short term.
You think to yourself, “This may bring dollar sellers back into the market, and I don’t know if EUR/USD will keep going down… I should lock in some profits.”
You decide to close half of your position by buying 5k units of EUR/USD at the current exchange rate of 1.2900.
This locks in $50 of profit into your account [at 5k units of EUR/USD, 1 pip is valued at $0.50…. you have closed a profit of 100 pips (100 pips x $0.50 = $50)]
This leaves you with an open position of 5k units short EUR/USD at 1.3000. From here, you can adjust your stop to breakeven (1.3000) to create a “risk-free” trade.
If the pair moves back higher and triggers your adjusted stop at 1.3000, then you close out the remaining position with no loss, and if it moves lower then you can just ride the trade to more profits.
Obviously, the trade-off for “taking some off the table” is that your original max profit is reduced.
Now, if EUR/USD ended up falling to 1.2700 and you had caught the 300-pip move with a 10k unit position of EUR/USD, then your profit would be $300.
Instead, you closed 5k units at a 100-pip gain for $50, and then you closed your remaining 5k at a 300-pip gain for a $150 gain ($0.50 per pip * 300 pips = $150). Together, this makes a $200 gain versus your original $300 max profit.
The decision to take some profit off the table is always up to you… you just have to weigh the pros and cons.
In this example, the trade-off is a better profit versus the peace of mind of a smaller locked-in profit and creating a risk-free trade.
Which is better for you?
50% more profit or being able to better sleep at night?
Remember, there is the possibility of the market moving beyond your profit target and adding more bling-bling to your account.
There’s always much to consider when adjusting trades, and with practice over many trades, you’ll find a process of taking off trades most comfortable to you.
Next up, we’ll teach you how to scale into positions.
You may be asking, “Why? Why would I wanna scale into a trade?”
Scaling into positions, if done correctly, will give you the benefit of increasing your max profit.
But as they say, “Higher reward means higher risk.”
If done incorrectly, the value of your account could drop faster than you can even think about clicking the close button on your trade. Before you know it, you’ll be staring at your computer screen, eyes wide open watching your account get margin called.
Now we don’t want that to happen right?
So pay attention in class!
What separates “the correct way” from “the incorrect way” is the profitability of your open position when you add, how much more you add, and how you adjust your stops.
In the next two sections, we’ll teach you two potential scenarios for scaling into a position. Since traders are “risk managers” first, we’ll also touch upon the “No, No’s” of adding to an open position.