Is Scaling Out a Fallacy?

[Pabst]

Quote from darkhorse:

I've thought about this from a longer term perspective (not daytrading).

In addition to the psychological element, which is subjective, I think scaling can have value by smoothing out the volatility of returns over time, while still accounting for the uneven way in which the market distributes profit.

Swing and position traders might have a handful of trades that make their year, standing out dramatically in relation to the other 90 percent of trades.

If you press hard every time waiting for the rare big score, you will give up a lot of short run profit in reversals / setbacks etc. and potentially get yourself mired in extended drawdown.

On the other hand, if you always take profits at a predetermined point, you automatically disqualify yourself for those occasional huge wins--and it becomes much harder to exploit the trends that literally run for months (like VLO or FNM or RGLD etc). In my opinion the market does not distribute potential profits equally--like earthquakes and forest fires, trends tend to follow a power law. Rigidly predetermined exits ignore the potentially exploitable effects of that power law.

Scaling thus serves a few useful non-psychological purposes for the swing / position trader:

By taking partial profits at a predetermined exit point, you smooth your equity curve and better avoid long droughts.

By maintaining a partial position, you stay in place to exploit the sweetest trends, and retain the option of re-adding to your existing profitable position if the timing is right.

Furthermore, if you use a 'pig at the trough' approach to your available capital, scaling out frees up money for new positions without requiring you to give up on profitable current trends.

You simply give yourself more options.

As usual your contribution here is an unheralded gem.

I scale out often. I think it plays to me psychological weaknesses. The great trend traders are adding on as others are scaling out. We all love to reduce exposure to potentially explosive profits for the sake of picking up nickels.
Most of my bad drawdowns follow the premature exit from a solid position. Unfortunately a smooth equity curve is rarely a precursor of future performance.

 

[darkhorse]

Quote from Pabst:


I scale out often. I think it plays to me psychological weaknesses. The great trend traders are adding on as others are scaling out. We all love to reduce exposure to potentially explosive profits for the sake of picking up nickels.
Most of my bad drawdowns follow the premature exit from a solid position. Unfortunately a smooth equity curve is rarely a precursor of future performance.

The TF greats are often willing to risk 40 and 50% drawdowns too... Not everyone's cup of tea

In terms of adding on, few have said it better than Stanley Druckenmiller:

"The way to attain truly superior long term returns is to grind it out until you're up 30 or 40 percent, and then if you have the convictions, go for a 100 percent year."

Earn the right to be agressive by first demonstrating an ability to be conservative; then have the courage to go big at the intersection of strong equity curve and strong convictions.

(Of course, this assumes a discretionary element -- varying conviction levels don't really apply to the binary nature of mechanical systems.)

Similar to poker: not many guys can protect their chips for most of the night, laying it down hand after hand, and then go big at exactly the right time. Most players (and traders) revert to their natural personal style, be it conservative or aggressive, and thus find themselves limited by a lack of dimensionality.

 

[stephencrowley]

What about scaling out of stops?

Sometimes prices drop just far enough to stop you out and then jump right back up. If you spread your stop between 4 prices and 1 gets triggered.. bounces up and you take profit on the 3/4 left on the table.

 

[mtzianos]

I scale both in and out.

I think for each one of us, our scaling experience/method is very dependant on the specific market being traded, e.g. when daytrading liquid / low-range markets (e.g. bonds) one has few chances to succeed unless both entry and exit are very carefully planned and executed.

As one pic is a thousand words, last few days I've been posting some (exctracts) from YM trading executions in the "YM traders" thread:

(these URIs are just the pics, in the YM thread I have added a short comment)

 

[condorll]

scale in..........get out FAST!!!!!!!!!!!!!!

 

[maxpi]

I have been wrestling with the idea of scaling in for a couple of weeks. Let's say I have a mean reversion system that fires off a buy when price is a certain measure away from the mean. Let's say I have 4 levels where price will trigger a buy and I double the amount I buy at each level. As the price moves away from the mean the reward/risk gets better and I end up putting more money in to the trades with the best reward/risk ratio. It really is an account volatility issue however, as I put more and more of the account into one issue I am getting a better return on the average but I am risking a big loss to do it because eventuall I am going to pour money into an issue that never reverts to the mean, it is inevitable. If I want to smooth the equity curve I will just buy at the first level and accept the smaller returns with smaller risks. If I have money to rebuild the account I can run with doubling down and 100% margin if I want, I just have to know that it will blow up or suffer a severe drawdown eventually and I have to be prepared to deal with that.

Max

 

[keafan]

Cash

as others have said, taking off part of the position at a predetermined level reduces the p&l volatility (smooths out the equity curve). it also increases the win rate and provides positive slippage. if that is what you are looking for then use scaling out. if you don't mind extended drawdowns and like the feel of the 'big win' then hold everything with a trailing stop.

 

[Kicking]

scaling out is the cornerstone of succesful trading. You never nail top and bottoms, often the market reverses and all your profits vanish, trailing a stop means giving back profits. Scale out !

 

[Thunderdog]

Quote from darkhorse:

I've thought about this from a longer term perspective (not daytrading).

In addition to the psychological element, which is subjective, I think scaling can have value by smoothing out the volatility of returns over time, while still accounting for the uneven way in which the market distributes profit.

Swing and position traders might have a handful of trades that make their year, standing out dramatically in relation to the other 90 percent of trades.

If you press hard every time waiting for the rare big score, you will give up a lot of short run profit in reversals / setbacks etc. and potentially get yourself mired in extended drawdown.

On the other hand, if you always take profits at a predetermined point, you automatically disqualify yourself for those occasional huge wins--and it becomes much harder to exploit the trends that literally run for months (like VLO or FNM or RGLD etc). In my opinion the market does not distribute potential profits equally--like earthquakes and forest fires, trends tend to follow a power law. Rigidly predetermined exits ignore the potentially exploitable effects of that power law.

Scaling thus serves a few useful non-psychological purposes for the swing / position trader:

By taking partial profits at a predetermined exit point, you smooth your equity curve and better avoid long droughts.

By maintaining a partial position, you stay in place to exploit the sweetest trends, and retain the option of re-adding to your existing profitable position if the timing is right.

Furthermore, if you use a 'pig at the trough' approach to your available capital, scaling out frees up money for new positions without requiring you to give up on profitable current trends.

You simply give yourself more options.

Very nicely stated. I think that the principles apply equally well to intraday trading.

 

[FredBloggs]

its all going to depend on your business plan

if youre a position trader going for a long term trend, then scaling out isnt going to do you much justice. you accept a low win rate, and you go for the big wins every now and then. scaling out will just bring down your potential payout. youd be shooting yourself in the foot.

if you are a daytrader as most here probably are then scaling out probably does make sense. in the current market - especially in the equity arena, there are very few real trends, but plenty of intraday swings. going to the bank at predetermined levels clearly makes sense, and also leaves you with a potential plan to go to the hills if you still have some left when that major daily level you had your eye on is breached.

as for scaling in as some have touched upon, then again the reverse is true.

the position trend trader may want to dip his toe in the water and pyramid as the move progresses and his confidence builds that this is 'the one'.

the day trader though has a different scenario. if hes right, he needs to be right straight away. there may be no second chance....