Hello traders! In my last Lessons from the Pros article, we discussed the tendency of many new traders to “chase” trades, that is enter well after the optimal entry level. This week I’d like to expand on a slightly different way to enter your trade.
You may have heard the old trading phrase that goes something like “entering your entire position at one time is the height of arrogance.” What this basically means is that no one is good enough at trading to buy the absolute bottom in price to go long or the absolute top when going short, at least not consistently! The theory is then that you should scale in to the trade, adding to it as long as your original analysis is still valid. This idea of scaling in or adding to a position does not mean you get to blindly add to a losing position until it finally goes your direction; this is one of the most basic fundamental mistakes that blow up people’s trading accounts! What I am referring to is the pre-planned adding to a position at or near a high quality demand or supply zone. When we say pre-planned, what are we planning? Our total risk in dollars.
In this GBPUSD chart, I’ve identified an upward sloping trendline that intersects a high quality demand zone. Using the entry styles that we cover in our Online Trading Academy classes and in our Extended Learning Track rooms, your first (and most aggressive) possible entry using that zone would have been at point labeled “1”, as price first touched the top of this zone. Your second possible entry would have been inside the zone, perhaps at point labeled “2”. Your third (and most conservative entry) would have been as price was leaving the zone, point 3. Very briefly, the basic difference of each entry are: 1. Most trading chances, not the best reward to risk ratio, worst win loss ratio. Entry 2: Fewer trading opportunities than 1, better reward to risk ratio, better win loss ratio. Entry 3: Fewest trading opportunities, worst reward to risk ratio, best win loss ratio. Each style has its own goods and bads, this is just a brief comparison.
So, as we are considering “dipping our toe in the water” on our trades, testing our level before we put a large position on, what else should we consider? If you answered “risk management,” congratulations! Let’s say you have a $10,000 trading/investing account, and on this trade you are willing to risk 2% of your account. Because you aren’t sure exactly at what prices all three entries will be, I’ll use the top of my zone as my average cost of my trade. In this example, my entry will be calculated as 1.5580, with my stop loss for all three entries below the zone at 1.5555. The profit target will be set at 1.5655. With a 25 pip stop and a 75 pip target, my reward to risk ratio is 3:1. Two percent of my account is $200, dividing that figure by the amount of my stop, I can do a total of 8 mini lots maximum.
As the price hits the top of the zone, you could have a limit order set to enter two mini lots at 1.5580; this would be the only way to enter the trade if the price immediately bounced off of our demand zone. As the GBPUSD continued to move into the zone and then slow down, you could enter another two mini lots a bit lower than the original price. Often traders will use a market order here, perhaps looking for a reversal candlestick pattern to confirm their entry. Our third entry of two more mini lots would be executed as price left our demand zone-perhaps by using a buy stop limit for our final entry.
Notice we only entered 6 mini lots, when 8 was allowed with our risk management rules. In every Online Trading Academy class that I teach, I always recommend new traders to be conservative, better to risk smaller amounts until trading becomes boring and profitable for you! Using this technique you are limiting losses if your first entry into the zone doesn’t work out.
Always remember that adding to a losing trade is considered a bad trading tactic. However, when your total trade is taken into consideration before any lots are entered, we reevaluate this general rule of thumb. With this scaling in technique, very often your confidence in your trading skill will increase because you aren’t so stressed when you enter a smaller sized trade. As the level holds, your confidence in your skill will increase much faster than the traditional all-in, all-or-nothing trading style.
Until next time,