Aug 212011

Yesterday UC asked some very good questions and I thought a response would be worthy of a new post:

Hi Michael,

Nice diary.

I have few questions for your regarding scales and lots and one observation about your latest post.

Reading FT71 steam on twitter and recently seeing Don Miller’s “trading after dark – episode 6” i realized that trading with 1 lot vs trading with multiple lots is a completely different business. I see you are using 2 lots. my questions is do you think you can still be in positive territory at the end of the week trading only one lot? I ask you this question because in the last 2 months with 2 point hard stop and trading only one lot i quite damaged my trading account. my interpretation is that current market conditions require to adjust one’s trading strategy – on one hand – but also it makes life much more difficult for day traders and maybe trading 2 lots (scaling out 1 lot to hedge position after 1-2 points – would be better. Next two weeks i’m going back to sim trade to see if this plan works out or not. any thoughts from you on this would help.

Regarding your last posts, entering trades between levels, wouldn’t just mean to destroy the idea of levels and trading plan? I would rather use rotations/pullback to add or cut on a position. As I mentioned above i trade only one lot, so take this observation for what it’s worth.

Thanks a lot.


The first question is about scaling out.  I’m not a fan of scaling out at a set profit target at anything below a 2:1 R:R ratio.  I believe that is cutting winners short.  I think of it this way:  If I traded only 1 contract, could I make money taking profit at 1-2 pts?  I believe the answer is that I wouldn’t make much money.  So if it’s not profitable then I shouldn’t do it.

If one thinks about a 2 lot trade as two separate trades, then both trades must be profitable long term.  Having the first lot be unprofitable doesn’t make any sense.

So when do I believe it’s good to scale?  I can think of two reasons, the first is if you see a change in the order flow.  Let’s say you’re long and then you see buying get real weak and sellers coming in. Even in this case, I don’t want to do it unless my R:R is at least 1:1 and I prefer 2:1.  The reason is if I get long while price is going down, there are always going to be sellers who take another stab at a short.  And I don’t want these sellers to trick me into exiting half my position.  I prefer to just let the market prove me wrong by stopping me out so that when I’m right I can get paid.

The other reason is to take profit ahead of a S/R level which you expect to cause at least a small retracement.  This makes sense, but if there is such a level at less than 2:1 R:R then I don’t want to take the trade.  For example if my stop is 2 pts and there is a level 2 pt away, I’m not going to enter the trade.

So putting these two concepts together, I want to take my first scale as late as possible.  Lately I’ve been putting my two targets quite far away and I will scale out if & when I need to.  This results in a good profit on the first scale.  In fact in a few trades I got a good profit on the first scale and then the second stopped out.  That’s ok because I’m going for a big win and when I get it I will have a very profitable day.  The increased volatility makes this possible.

FT has said he takes a scale at 1-2 pts.  But keep in mind he is trading at least 8 units so he can take off 1/8 of his position at 1-2 pts and it’s not going to have a huge impact.  However if one takes off 1/2 their position at 1-2 pts it’s not the same.  So we must be careful in applying these concepts as they are heavily influenced by the number of units one trades.

Regarding 1 lot trading.. many of my good trades are done with a single lot.  Why?  Because I see price coming up to a level but I’m not sure price is ready to reverse, I’ll enter 1/2 my position.  And sometimes price will just reverse and take off in my direction and I never get to add the second position.  In these trades I go for a big win since I can’t scale and often get it.  I debate entering my full position instead of half but the other half of the time price goes a bit farther into my zone and I get the 2nd contract at a better price.  So I’m still undecided.  But what I want to say is one can trade 1 lot profitably.  If one is scaling out too quickly with 2 lots then I think trading 1 lot is the cure.  Just make sure your R:R is 2:1 or greater, ideally 3:1+.  Then your win rate can be below 50% and you can still be profitable.  When profitable with 1 lot then try 2 and have the second lot be at a larger target.  In other words, then one goes from 1 to 2 lots, you don’t want to bring the first target in.  That doesn’t make any sense at all.  Rather than doing that, it’d be better to trade 2 lots with a single target.  For me the advantage of 2 lots is I can go for a little more on the second and ride the move.  That’s how FT can stay in a trade for hours.  He scales out 1/8 at levels and has more staying power.

Another example of when I trade 1 lot is when it’s really volatile and my stop is 4 pts or greater.  I trade 1 contract in this case and I go for 8 pts.  This is mainly when the market is very volatile.  And another example of when I trade 1 lot is if I’m fading counter-trend.

I just went through my trades from July 1 to present and I filtered out all the real money ES trades where I only traded 1 contract.  The expectancy is $57.  That doesn’t mean I’m going for 1 pt, that’s just what the average works out to be.  I had a $700 winner, a $300 winner, and a $228 loser in there.

When I do the same thing with my ES real money 2 lot trades, I get an average of $81 per trade which is $40 per contract.  Surprisingly that’s less!  How could that be?  I believe it’s because I was too quick to scale out of the first position.  The numbers tell me I’d be better off trading with one target.

Except there’s a slight catch.  As I explained, some trades barely touch my level (or even come short) and then take off in my direction.  So that accounts for part of the reason why 1 lot is more profitable.

Intrigued, I did the same thing for August only.  1 lot trades averaged $104 while 2 lot trades averaged $117 which per contract would be $58.  I think this makes a good case for going for big R:R trades and not scaling out.  I’m going to be paying more attention to this in the next few weeks.


The second question is about trading between levels.  This doesn’t “destroy” the trading plan if my plan is to take specific setups in between levels.  And if I can do so with a tight stop and a target at the next level, it can be profitable.

What I find is when I don’t get an entry at a level, or more precisely in a zone, then I have to wait for the next zone which could be quite later.  If I can enter on a pullback then I can get in on this missed trade and ride it to the next level.  Sometimes zones are quite far apart so this makes a lot of sense.

An example is a 1-2-3 low.  Let’s say point 1 is at my level but I miss it for some reason.  Then it pulls back and makes pt 3 and then it comes down to retest pt 1 and falls short, creating pt 3.  This pt 3 is a good low risk setup.  The stop can be below pt 1 and I’m seeing weakness since it couldn’t get to pt 1 and make a lower low.  This this is an example of entering in between levels.  And in this case I think it can be more profitable than entering at the level, especially when fading.

For me, the key to entering in between levels, actually the key to entering all the time, is to time the entry based on the order flow.  I know that’s an overused buzzword but I’m not sure what else to call it.  Buying pullbacks is hard because you don’t know when the pullback is over.  Just like I don’t know when pt 3 makes a higher low until well after the fact.  But if I see selling getting weak, absorption on the bid, and then buyers lifting the offer, I can guess the pullback is over and enter my trade.  And by entering this way, I know right away when I’m wrong.  Either the pullback is over or it’s not.  When timing entries this way, it’s possible to get very tight stops of 4-6 ticks.  The problem is often these setups don’t work so it could stop me out a few times and that’s why the R:R has to be good.

I’m not recommending that everyone use “order flow”, as it takes a lot of practice & experience to learn how to use it.  I’ve been using the volume ladder for a year and a half now and I’m still learning.  I’m just saying this is one way to help time entries and get a tight stop.  FT doesn’t use the ladder so one can do it with the DOM and Time & Sales also.

Now some things specific to UC.  If you look at my equity curve, you’ll see the past 2 months have been very difficult for me.  I did very well in May, my equity curve was like a rocket.  That rocket ran into trouble in June & July.  And I’ve had to adjust my trading to the current market conditions.  I agree with you that one must adjust, but adding a contract just to scale out at 1-2 pts is not the answer IMHO.  I believe the opposite, trading 1 contract with a bigger stop and a bigger target is the answer.  The increased volatility means you can have proportionally bigger targets than stops (thanks to eminiwizard for sharing this concept).

The other idea would be to avoid fading.  The market has been trending and you don’t want to fight that trend.  Fading in May worked great because there were very few strong trend days.  But that’s no longer the case.  So adapt.

If you want to share some trades you made we could investigate this further.

I want to stress that everyone has to find out what works for them and I’ve shared my ideas about what works for me.  If someone is doing something different and is profitable, I wouldn’t argue with them or try to change their mind.  But if someone is not profitable then hopefully sharing some ideas can help.



  5 Responses to “Scaling out and trading between levels”

  1. Much appreciated.

    Illuminating the answer to the first question, and agree that trade between levels is not disruptive for the plan.

    Now I see how FT1 scale plan cannot work if one trade 1 lot only.

    I would meditate on stops and targets. But now it’s much more clear that going for biggest profit keeping
    larger stops is the way to go. R:R 1:2 or 1:3.

    Very nice and telling your statistics on performances with 1 and 2 lots.

    Wish you a successful trading.

    Thanks again


  2. Great post and great blog. Keep it up! Been a long time reader.
    It’s funny because I’ve been spending quite a bit of time pondering about the topic of scaling out and lo and behold… someone writes something about it on the web. 😉 For what it’s worth, my current perspective on scaling out is that it’s really a risk-reduction strategy (it might very well change later).

    Assume one trades 3 lots with an initial 3 point stop. (Total risk = $450, excl commissions). If the trader scales out of 1 lot after making 1.25 points, the risk on the remaining position is reduced by 47% to $237.50 (even though the stop on the remaining 2 lots is still 3 points).

    Therefore, by getting that first scale out, I accomplish a few things
    1. I reduced my risk per trade
    2. I’ve relieved myself of some pressure, and i feel a little bit better emotionally.
    3. Assuming I have a daily loss limit of $2000, i would only be able to take 4 losing trades using 3 lots with a 3 point stop. But if i can get the 1st scale on each of my trades, I can take up to 8 losing trades before i hit my daily loss limit – each losing trade eats up a smaller chunk of my daily loss limit.

    So in a way, I am saving myself some ammo for opportunities that may show up during the day. It sucks to miss a trade because I’ve hit my daily loss limit. Having enough ammo keeps me in the game long enough to make a success out of this endeavor – hopefully.

  3. MK – have you made stats on the profitability of each unit? I’m very curious to know if your first scale is profitable. For example if you traded only the first unit and took profit at 1.25 pts, would it make money? What about your second scale?

    Then you can do scenarios such as instead of taking profit at first scale, what if you took it at the second on 2/3. Would that make more or less money? I’ve done things like that in the past and found that if my first scale was too quick it fell into the “cutting winners short” category.

    Psychologically it can really help, but mathematically it’s not so clear.

  4. I don’t know if this will still be an active topic, but I would like to drop a comment. I have been trading multiple contracts 2 – 4 ES. After reading this topic and Barry Taylor’s comments on scaling I am rethinking my plan. I have reduced to one contract increased my initial stop and I am attempting to go for the 2:1 ratio. I had been scaling my first contract between 3-4 ticks and then moving my stop up to protect. Which felt good, but mathematically wasn’t working for me. I would get stopped out again and again. This was my first day and it worked well. Stress was down with the reduced size and I let the trades work without micromanaging them.
    I hope everyone traded well.

  5. Hi Paul,

    If you take all your trade data and calculate the expectancy for your first contract, that would tell you if it was positive or not. If you take 3-4 ticks on a winner and 2 pts on a loser then you have to have a good win rate (on the first contract) to make it work.

    I”m still experimenting with this myself but lately I’ve been going for 2 pts on my first contract and I put my stop at entry – 2 pts so I’m at no risk and i let the 2nd contract go. I’m experimenting to see if I should go for 4 on the first contract. It’s a lot of experimenting and fine tuning to find out what works best for each of us. I’m glad to see you taking the time to experiment with it. Let us know how it goes.

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