I was thinking of different ways of controlling risk when averaging down (or rather scaling in) on an intra-day basis in the futures market. The issue I have is whether to use a certain price level/area where you exit for a loss, or rather a monetary stop on the trade.
The other aspect is that with averaging down you end up with a huge loss on your max position size and make frequent profitable trades with a smaller size. How do you deal with that? You enter the trade, starting small, it goes in your favour, you close it - then I regret it was only, say, 1/10th of the max position size. I would appreciate any advice on how to deal with this issue - how do you manage this?
You have raised many valid issues that I have been dealing with on my own. Let me add my $0.02 to that discussion to share my own experience.
Let's start with the basics, because w/o them this discussion is going one way street of "never average down", (which is so true). What is "scaling-in" and what is "averaging down"? To me the difference ends up simply whether there was a strict plan beforehand or not. Averaging down is taking on full position and instead of booking the loss you add more to make $ or exit BE. It is always a decision made w/o plan. Scaling-in on the other hand, regardless if done on way up or down (in position P&L terms) is strictly pre-planned process and as such means that initial entries are small (toe-in the water) and you may build up (or not) to your full position later on.
Averaging down should be avoided like a disease! I have done my share of averaging down over the years and it ALWAYS ended up with big blow outs. Catching "falling knives" is nothing even remotely comparable to averaging down which will kill your account and might even kill you (no joke).
With the basics above clear, let's concentrate on scaling-in which means building your full size over time/price. It may be done on way up or down (in P/L terms) but let me focus on scaling-in when the price goes against you, as that's the most controversial aspect.
In my humble opinion, that kind of "scaling-in" has to be discussed together with psychological aspect of trading because it is more important here than with other forms of entering the markets. What OP asks in his opening posts are valid questions that show (underneath the surface) what that kind of trading deamons you have to deal with here.
If your initial entry is right of the bat, trader, instead of being happy can actually become "upset" with small win due to the small initial position, just like OP said. Normally no trader would be happy with market moving against his/her position. But guess what, now your mind starts to "like" when the market goes against you because you can scale-in at better prices and potentially make more money... That psychological aspect can lead the trader to abandon his trading plan, assuming he/she even had one in the first place (!) and force him/her to "average-down".
Therefore the most important part of trading by scaling-in, in my humble opinion and experience, is having a clearly defined PLAN and following it religiously. Yes, all trading should be based on execution of a plan. But as pointed out earlier this one will be harder to follow due to the nature of that kind of trading. You will be constantly challenged to ignore the plan, since any price against you is always a "better" price.
The plan needs to generally define your entry criteria like size of initial entry and where you would generally enter and scale-in, that will be finally adjusted on the trading day depending on what you like to use in your trading. But you may want to set an absolute nominal loss that you will take no matter what as a last resort protection. Also determine upfront how would you exit/scale out of positions. This is no different that with any other type of trading.
That kind of trading style intraday relies heavily on the fact that there is too much noise to trade with tight stops. It can be used for outside-in trading where no one way directional moves are expected or for trading on pullbacks for continuation of the impulse move intraday.
To give you an example: let's say you normally would trade 2 lot ES with 2.5-3pt stop. You conclude that when market is two-way trading w/o clear longer OTF participants active, you will fade outsized moves up or down at the predetermined levels (whatever you use for S/R) looking for mean reversion or at least good pullback rotation. You wait until the days range reaches certain point (per plan) and if there is a good S/R area you enter 1 lot. Your plan says that you may scale-in at 4-6pt against you with another 2 lots with a hard stop on the entire position that is no more than 10pts total on sum of all contracts traded (3-3.5 per lot). There is even bigger S/R level 5pt against your original entry so you place another order for 2 lots at -5pts to your original entry with a hard stop of 2.5pts further on all (10pts risk on sum of all 3 lots). Your plan also says that if you do scale in, you will exit all either at hard stop (no exceptions) or with a profit at your original entry (booking 10pts).
As a result, you have to ACCEPT that there will be days where you make small win on small original position. But as you have pointed out, the mind will play tricks on you trying to force you into bigger initial position next time and therefore pushing you into "averaging-down" territory. There will also be days when you exit at a loss on your biggest position but that's when sizing and risk per plan comes into play.
As a side note: Intraday, I would think that scaling-in more than once (after initial entry) probably should be avoided (I have a problem with that). I can imagine 2nd scale-in (3rd entry) with a very tight stop but anything more than that would definitely fall into averaging-down category.
There will be a lot of traders that would disagree with that kind of trading, that fading by scaling in. I'm fine with that and I'm open to any constructive criticism. I've noticed over the years that my psychological makeup makes me biased and prone to fading and I will either (a) weed it out of my brain if others convince me to it, (b) accept that "weakness" and use it to my advantage by embracing it for use with that trading style or, (c) it will bring me down eventually. So any further discussion would be welcomed.
My own fuckups with that strategy were always due to not having plan in the first place or ignoring my plan by acting in the heat of the moment (i.e. scaling in on every 1.5-2pt against as opposed to 4-6pt per plan, ignoring max daily loss etc). I concur that my own reading of the day's PA action incorrectly (I mean not seeing the rather obvious) was never that bad for my bottom line as was ignoring my plan on position sizing and max loss per trade or day.
