A trader\'s money management system

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c08 JWBK182-McDowell April 25, 2008 16:4 Printer: Yet to come

Scaling Out and Scaling In 69

2.Add additional trading capital to your trading account to allow for a

larger position while still keeping risk within 2 percent.

Another alternative is to use the leverage of options, but you must be

familiar with options, their time value decay, delta, and so on. Using op-

tions would be considered a specialty or advanced technique, and if you

are not familiar with them, this method could lead to increasing your stress

and your potential risk.

SCALING OUT EXAMPLE ON THE E-MINI

Using the e-mini as an example, your account size is $25,000 and you

choose to risk 2 percent on this trade; 2 percent of $25,000 is $500. Your

trade entry is 1037.75 and your exit is 1036.25, so you can buy approx-

imately six contracts and stay within your risk parameters. (In this

example, we are risking 1.5 points per contract, which is valued at $50 per

point.) If you get stopped out before having a chance to scale out, your

loss would only be 2 percent. Therefore, this potential risk should not

create any stress.

Only when your trade becomes profitable does scaling out come into

play. At the point your trade becomes significantly profitable, cover part of

the position and liquidate enough contracts so that if you are then stopped

out, you will still make a profit. If the trade becomes even more profitable

and you have a large enough trade size, then you may want to liquidate an-

other portion of contracts to lock in additional profit. The remaining por-

tion of your position should stay in place.

Until you get stopped out, you should be able to enjoy the rest of the

trade and let it go as long as the trend continues, knowing that no matter

what happens, at the very least you will make a profit on this trade. Look

at your trading system to determine if there is some type of reversal signal

that will tell you when to scale out. Work some rules into the plan so that

your decision to scale out is based on a technical or fundamental signal of

some type.

When trading only one or two contracts, you can’t scale out of posi-

tions in a meaningful way. This is another reason why larger trading ac-

counts have an advantage over smaller ones. Also, some markets are more

expensive than others, so the cost of the shares or contracts will determine

your trade size.

Remember that in choosing your market, liquidity is important, and

you must have sufficient market liquidity to successfully scale out of posi-

tions. Poor fills due to poor liquidity can adversely affect this technique.