Quote from CBuster:
Without wanting to spend ages with loads of specific examples:
Consider a situation where I am long a stock from 25.00. My research tells me that the "optimal" profit target is 25.25. Stop might be 24.75. Market edges up to trade .20 or .21. My system might begin to scale me out around here. If market reverses back to b/e or worse, at least I have partial profits. If market rises to my original target, I miss out. i.e.
- In a situation where I wou have been right to wait for 20.25, my equity curve is upward sloping, but not as steep as it might have been.
- In a situation where the market reverses before hitting the optimal target but after some move in my favour, my equity curve is (shallow) upward sloping, rather than flat or even down which it would have been if I had held out.
[edit] - thus u can see that, in both scenarios, equity curve is up-sloping with scaling out vs occasional dips if holding out for the optimal target
This is very a v simple example and I am not advocating always scaling out or super tight profit targets, etc. Results will depend on the strategy at hand and other trade management rules. However, overall it is easy to see how scaling out CAN, and often(but not always) will result in smoother equity curves (but ultimately less profit per share).
Of course, you can also argue that, even if the optimal profit target gives higher profit per share over the long run, if scaling out does indeed impove consistency / risk adjusted returns, we can grow size more rapidly and hence make more total money this way anyway. That's my approach - when market capacity becomes a problem (cannot up my size any more), it might be worth reconsidering.
