"Scaling out" is inferior behavior

[GTS]

Wow, I agree with B1S2 and can't believe that others don't see the obvious truth in what he is saying.

It may feel good to scale out after making 3 pts and hold the rest for the full 6 pts but the bottom line is that one or the other is the correct place to sell everything.

Psychologically it is comforting to take some money off the table and increase your w/l rate but financially it is a sub-optimal thing to do.

I don't see how this is up for debate - all it would take is a mechanical system, run it with three different parameters sets:

First sell everything at 3 pt profit target
Second sell everything at 6 pt profit target
Third sell half at 3 and half at 6pt

There is no chance that the third scenario is going to outperform both of the other two. Either selling all at 3 or selling all at 6 is going to be superior, doing half and half (scale out) just waters down the optimum strategy with the sub-optimal strategy.

I guess if you don't know what your optimal exit point (profit target) is then scaling out could make sense but it seems like it would be worth your time to go through your trade history and figure when the optimal exit point is (would have been) and then just use that going forward.

Maybe I'm missing something but it seems pretty black and white to me.

(Edit: This is not to say that I never scale out, just that I realize what I am doing is not optimal - being human sucks like that)

 

[HolyGrail]

Quote from GTS:

Maybe I'm missing something but it seems pretty black and white to me.

(Edit: This is not to say that I never scale out, just that I realize what I am doing is not optimal - being human sucks like that)

I guess the point you are missing is that there are no guarantees you will get the full 6 points and it can just as easily turn the other way. Just because one sets a target does not mean that target is DEFINITELY going to be reached. It's a goal, and that's all. Even if the goal is reached there still might be a chance the stock will continue to move higher. You would still scale out a portion and let the other part run. Personally I like to scale down to a point where I am playing with the house's money. Yes, I know it's still my money, but there is a great deal of comfort in knowing there is no way you could lose on a trade.

 

[GTS]

Quote from HolyGrail:

I guess the point you are missing is that there are no guarantees you will get the full 6 points and it can just as easily turn the other way. Just because one sets a target does not mean that target is DEFINITELY going to be reached. It's a goal, and that's all. Even if the goal is reached there still might be a chance the stock will continue to move higher. You would still scale out a portion and let the other part run. Personally I like to scale down to a point where I am playing with the house's money. Yes, I know it's still my money, but there is a great deal of comfort in knowing there is no way you could lose on a trade.

I think you are missing the point, the idea of playing with house money is a psychological cruch - it means you are trading suboptimally just to make yourself feel better. Wouldn't having more money at the end of the year make yourself feel better instead?

Let's say out of 100 trades, if you had used a 3 point target you had 50 winners and 50 losers; and if you had used a 6 point target you had only 30 winners and 70 losers. Assume a 1 point stop loss for the losers.

Now given that, what should you do with this strategy, sell everything at 3 pts, sell everything at 6 point, or scale out half your position at 3 pts and hold the rest for 6 pts?

Before you tear apart my example feel free to make up any scenario you want with targets and ratios - the bottom line is that selling at one point or the other (no matter what those two points are) will always give you better returns over the long run then selling half and half. It's a mathematical fact (unless it just works out perfectly that the returns for either target are equal in which case do whatever the hell you want)

 

[austinp]

While I watch the charts wedge into typical index-option expiry death coils, let me add a couple of thoughts:

#1: In writing countless mechanical systems, every example with no exceptions showed diminished overall profit AND smaller profit per trade size using a scaled-out approach.

Why? Very simple. Some trades over a large sample size will go z-number of points in favor of typical entry signals. w-number of trades will immediately go against the entry, and y-number of trades will slop around in sideways fashion.

When building a system - method - approach, we must have some idea where to harvest profits from. That is critical for several reasons... in picking initial stop-loss / risk parameters, and managing winners.

In order to maximize overall returns AND per trade profit size, those z-trades need be captured in highest efficiency possible. There is no good way to manage the y and w type trades... they never offer much if any real profit potential.

The z-type trades are where an account balance grows. That is the edge, that is the bankroll. Any tactics used to exit z-trades early will directly diminish said bankroll.

In order to know our trade approach is sound, we must first prove that some number of trades will go far enough in favor to offset all else. If we know for a fact that exists in our approach, we must therefore treat <b>each and every trade</b> as if it will be a z-type result for maximum overall profit and per-trade potential.

*

Here's the human pitfall which overrides system trading: emotion places <u>more emphasis on each and every single trade</u> than emphasis on overall cumulative data from large sample size.

Said another way, we trust that some trades will progress far enough past entry to make us overall profitable, but we fixate on the results of the current trade more than overall blend of results.

You see where I'm going. Traders do go broke taking profits... that happens all the time. It happens because they take too small profits from z-type trades which is the essence of their edge. Little can be done to manage the rest, so small profits are erased = negated by small losses.

**

Whether scaling out is wrong for everyone or not is debatable. What is a mathematical fact on the topic? Write any mechanical system and add scaled out partial profit rules instead of all-out rules at optimum AVERAGE profit size. See what the results are in overall profit and per-trade profit size for each scenario. I know the answer already... but you'll believe your own math a whole lot more than you'll believe mine :>)

Hope this helps and/or entertains

 

[GTS]

Quote from austinp:

Write any mechanical system and add scaled out partial profit rules instead of all-out rules at optimum AVERAGE profit size. See what the results are in overall profit and per-trade profit size for each scenario. I know the answer already... but you'll believe your own math a whole lot more than you'll believe mine :>)

Very well put - thank you!

 

[Jachyra]

Well said. Now imagine if you had an approach that allowed you to increase your position size on the z-trades as they progressed, so that you were weighted more heavily in them.

 

[HolyGrail]

Quote from GTS:


Now given that, what should you do with this strategy, sell everything at 3 pts, sell everything at 6 point, or scale out half your position at 3 pts and hold the rest for 6 pts?

Before you tear apart my example feel free to make up any scenario you want with targets and ratios - the bottom line is that selling at one point or the other will give you better returns then selling half and half. Its a mathematical fact.

I would do none of the above. I would hold a portion for LONGER than the 6 points depending on the stock and the overall condition of the market, and if it still met my holding criteria. Playing with the houses money is not a crutch. It catches extremely long runs.

 

[austinp]

The reasons given for scaling out of trades are usually based on emotion: release of tension = stress of unknown outcome with real money at risk. The mathematical part of scaling out versus letting profits run is quite easily examined. Even micro-scalpers (of which I am not one) need to ride out their winners a bit to make money overall.

<i>"A man convinced against his will, is of the same opinion still"</i>

Traders who decide = prefer to scale out of positions usually do so for emotional reasons. In reality, that is often a very important part of success or failure in the continued evolution as a trader.

**

The bigger question is, why the heck am I still watching the emini charts at all? This session ended many hours ago... someone forgot to turn off the Globex when they left the CME building.

 

[GTS]

Quote from HolyGrail:

I would do none of the above. I would hold a portion for LONGER than the 6 points depending on the stock and the overall condition of the market, and if it still met my holding criteria. Playing with the houses money is not a crutch. It catches extremely long runs.

(sigh) Whatever. I told you that you could use whatever examples you want rather than shooting down random numbers I threw out.

If that's the case then you should hold the entire position for longer than 6 points depending on the stock and the overall condition. Whatever targets you use, you are just reducing your returns by scaling out.

 

[HolyGrail]

Quote from GTS:

(sigh) Whatever. I told you that you could use whatever examples you want rather than shooting down random numbers I threw out.

If that's the case then you should hold the entire position for longer than 6 points depending on the stock and the overall condition. Whatever targets you use, you are just reducing your returns by scaling out.

No NO NO NO. Everything is based on probability of expected outcome. When you buy a stock for 20.00 expecting a 3 dollar return you are not likely to wait for that stock to double. It may never double, or it may double in the next six months. I let my free shares ride the wave and I just might catch that double. Trading all of my FULL positions waiting on a double or whatever target is ludicrous.