Last updated on April 18th, 2020
Trade setups and entries are one of the most searched for topics when it comes to trading. What gets missed is the exit strategy you will use to exit your trade for profit or at your stop loss.
I have a question for you: “How many times have you been in a trade, which has moved nicely in your favor but failed to meet your target, then came back to either give you a scratch or a loss?”
You’ve been there and it may have affected how you approach your next trade or even had a profound impact on your trading strategy.
Ask yourself this, “If I had taken something on each of those trades, how would that affect my strategy?”
It would allow you to bank something on more of your trades, but also it would diminish profits on those which do meet their targets.
Trailing Stops and Scaling Profits
If you are thinking of scaling out parts of your position to take advantage of the positive price action and locking in profits is important to you, it has to be based on an analysis of your trading methods results and potential results from doing so.
- How frequently does the strategy meet its targets
- How big are those targets
- Are there certain objectives that are met much more frequently than the overall target?
These are a few of the questions you’ll need to answer when looking at whether scaling out your profits is worthwhile for you.
Some traders disagree with scaling out partial profits on a trade with the big issue being your stop being based on a full trading position. So when you are underwater, you are probably going to exit fully compared with not holding a full unit when the trade does go in your direction
I’d point out that in this case you should have your stop loss where most of the time if it gets through, the market is likely to go much further. So exiting fully can protect you here.
In the case of not having a full trading position when it does go your way, how do you know it’ll actually reach your target before it hits your stop? If you have a much higher probability closer target, scaling out a portion of your trade just makes sense.
Benefits of Scaling Out and Trailing Stop Loss
Everything you do in trading must have a positive benefit or you should not be doing it. In the case of scaling out and considering the risk:reward has been taken into account, we are looking at:
- Profit retention; Lowers risk of whole trade due to better average of the position
- Less mental/emotional stress.
Let me define what I think of as a scale and a trail before taking a look at a few types.
- A scale is a minor profit target for a trade where a certain portion of the trade is exited
- A trail is the moving of your stop loss to minimize adverse price moves relative to your position
So how can be scale out partial positions and trail our stop loss? Simple answer is anything that works for you.
- You can use technical levels such as pivot points or profile levels as scale targets
- you can use a variety of moving averages as stops or even
- ATR based trailers
- You could even use RSI to define when a move may be ending then adjust your stop profile to be more aggressive in an attempt to retain more profit.
It’s up to you , but you need to robustly test your design and ensure that the average profit versus the average loss has the right ratio and you have a good % win rate.
My general approach to locking in profits and scale trading is quite simple:
- Take off a % of the position size at 1R.
- Stop loss goes to break-even
- Use an ATR (average true range) approach to trailing my stop loss
It’s not fancy and it may not be the best approach for you but it does take into account a few sensible trade related ideas:
- If price has traveled to the same distance as my risk, the trade has done what I expected. I pay myself at this point for a great trade
- If price decides to head back to my entry price where my stop now is, is price still doing what I expected? No. Time to exit as I now have negative feedback
- Using the ATR allows me to keep my trailing stop at a distance from the normal fluctuation of price. Anything outside of that in the opposite direction of my trade tells me something has changed.
As with anything related to your trading, consistency matters. Find what makes sense, ensure it benefits your trading system, put it in your trading plan, and follow your rules every trade.