This is a very common technique where traders take partial profits when a certain amount of pips, money or levels are reached. This should be calculated prior to opening the trade and need to be strictly followed in order to avoid fear, greed and other in-trade psychology issues affecting your decision.
We have lost count of the number of our students telling us stories of how they had an averaging plan in place but once the trade was opened all reason flew out the window. Invariably they regretted the lack of discipline afterwards.
Let is illustrate how Scaling Out could work. For instance, a trader goes long the USD/JPY at 115.20, the trade is made on 3 standard lots (3 x 100,000= $300,000). The trader places all stops at 114.90, he also intends to take partial profits at 115.30, 115.40 and finally 115.50.
If the market goes in the intended way, the profits would be:
1st lot - 10 pips from 115.20 to 115.30
2nd lot - 20 pips from 115.20 to 115.40
3rd lot - 30 pips from 115.20 to 115.50
The overall result would be 60 pips
If the market goes against our trader and stops him out, we would have the following results:
30 pips x 3 (lots) = 90 pips
In this example, when the trade goes in our favor the total pipage made is 60 pips, on the other hand when the market goes against our trade the total loss would be 90 pips. This results in a RR ratio of .667:1. With such RR ratio we need a system accuracy of around 65% to break even, to make decent profits we would need a system accuracy of around 80%.
When scaling out we need to pay special attention to the RR ratio of the overall outcome. Take for instance the following scenario:
A trader goes long - 3 lots of EUR/USD at 1.1950. All stop levels are placed at 1.1935 and plans to take partial profits at 1.1970, 1.1980 and finally 1.1990.
If the trade goes in the intended direction, the profits he will make are as follows:
1st lot - 20 pips from 1.1950 to 1.1970
2nd lot - 30 pips from 1.1950 to 1.1980
3rd lot - 40 pips from 1.1950 to 1.1990
The overall result would be 90 pips.
If the market goes against our trader and gets stopped out, we will have the following results:
15 pips x 3 (lots) = 45 pips
With these parameters we will have a RR ratio of 2:1. As we already showed you, with such a RR ratio we only need a system accuracy of 38% to break even; with a system accuracy of around 50% we will make good money.
We need to make something clear though, when scaling out this way, we are actually going against two basic principles: “the trend is your friend” and “let the profits run and keep your losses short.”
When a trade goes in our favor, it means that we probably made a good decision; we probably caught a good trend. By taking partial profits we are limiting our overall gain.
On the example above, our trader could have made 120 pips if he had set all take profit orders at 40 pips, this would be a 2.67:1 RR that will definitely put the odds in his favor.
Another important factor to consider is that as the trade moves in our favor, the chances are greater that we will win that trade, and as the trade moves against us, the greater the chances are that the trade will fail.
Wouldn’t it be more logical to scale out the other way? When the chances of losing our trade are greater? So that if that particular trade resulted in a loss, we lose less money?
Take for instance the following trade:
A trader goes long the AUS/USD at .7420 on two lots. All take profit orders are placed at .7480, the stop loss level from the first lot is placed at .7405 and the stop loss of the second lot is placed at .7390.
If the trade goes in our trader’s favor
1st lot - 60 pips from .7420 to .7480
2nd lot - 60 pips from .7420 to .7480
The overall outcome is a gain of 120 pips.
If the trade goes against our trader
1st lot - 15 pips from .7420 to .7405
2nd lot - 30 pips from .7420 to .7390
The overall result would be a loss of 45 pips.
This would give us a RR ratio of 2.67:1 again.
The idea is this, when we win a trade we want to be all in so we can make the most of it. Moreover, when the market goes against us, we want to be partially in, so we lose the least we can. When the market moves in our favor the trade has a higher probability of success, so it is not a good idea to take partial profits or to scale out, on the other hand, when the market moves against us, the probability of success gets smaller so it is a good idea to scale out. This way we are letting our profits run and keeping our losses short.
NOTE: An excellent strategy would be to pyramid in when the market goes in our favor and scale out as the market goes against us. If you spend some time developing a strategy like this one you will added another string to your bow in a very promising trading career.
So – what do you think suits you out of those Money, Risk and Trade Management approaches? It is most important to choose something that suits your style, personality and risk profile. Why not experiment with a few different approaches. Words of warning though; do not do this randomly or without a definite plan! We stress to our students that all trading decisions should be as part of a reasoned approach before you enter a trade, and not driven by emotions or indecision while the position is open