We examined how to scale OUT of a trade in the previous lesson. We will now demonstrate how to scale INTO a transaction.
The first scenario we’ll look at is adding to your holdings while your trade is losing money.
Adding more units to a “losing” position is a delicate affair that, in our opinion, should almost never be done by a beginning trader.
Why add more and lose more if your deal is clearly a loser? Doesn’t make sense, does it?
Now we say “pretty much” because if you can add to a losing position, and if the combination of your original position’s risk and the risk of your new position stays under your risk tolerance level, you can add to a losing position, then you are free to do so.
To make this happen, a specific set of rules must be followed in order for this trade adjustment to be safe. Here are the guidelines:
- A stop loss is necessary and MUST be followed.
- The levels of position entry must be pre-planned before the trade was put on.
- Position sizes must be pre-calculated and the total risk of the combined positions is still within your risk comfort level.
Let’s take a look at a simple trade example of how to do this:
According to the chart above, the pair headed lower from 1.3200, and then the market experienced some consolidation between 1.2900 and 1.3000 before breaching lower.
The pair retraced to the area of recent stabilization after bottoming out around 1.2700 to 1.2800.
Assume you believe the pair will return to the downside, but you are unsure of the exact turning point.
There are several ways you could enter the trade:
Entry Option #1
Short at the bottom of the consolidation level, the broken support-turned-resistance level of 1.2900.
The disadvantage of entering at 1.2900 is that the pair may rise higher, and you may have missed out on a better deal.
Entry Option #2
Wait until the pair reaches the top of the consolidation region, 1.3000, which is also a psychologically significant level – perhaps a strong resistance level.
However, if you wait to see if the market hits 1.3000, you risk missing the market’s return to the downtrend since it does not make it all the way up there.
Entry Option #3
You might enter after the pair tests the potential resistance region and then falls back below 1.2900 into the decline.
This is perhaps the most conservative strategy because you obtain confirmation that sellers are back in control, but you also miss out on entering the downturn at a lower price.
Entry Option #4
What should I do? Why not enter at 1.2900 as well as 1.3000? Isn’t that doable? Yes, it is! Just as long as you write everything out before the deal and stick to the plan!
Determine Trade Invalidation Point (Stop Loss)
Let’s figure out where we want to stop. Let’s say you choose 1.3100 as the threshold that indicates you were mistaken and that the market will continue to rise.
That is where your trade ends.
Determine Entry Level(s)
Third, we will determine the appropriate position sizes to maintain a safe risk level
Assume you have a $5,000 account and only want to risk 2% of it. That suggests you’re willing to put up $100 ($5,000 account balance x 0.02 risk) on this trade.
Here’s one method to set things up:
Short 2,500 EUR/USD units at 1.2900.
According to our pip value calculator, 2,500 units of EUR/USD equals $0.25 per pip movement.
You have a 200 pip stop on this position with your stop at 1.3100, and if it hits your stop, you will lose $50 (value per pip movement ($0.25) x stop loss (200 pips)).
Short 5,000 EUR/USD units at 1.3000.
Again, according to our pip value calculation, 5,000 units of EUR/USD equals $0.50 per pip movement.
You have a 100 pip stop on this position with your stop at 1.3100, and if it hits your stop, you will lose $50 (value per pip movement ($0.50) x stop loss (200 pips)).
If you are stopped out, this amounts to a $100 loss.
Isn’t it simple?
We have set up a trade where we can enter at 1.2900, and even if the market moves higher and we end up with a losing position, we can enter another position and stay within normal risk limitations.
In case you were wondering, the combination of the two trades results in a short position of 7,500 EUR/USD units with an average price of 1.2966 and a stop loss spread of 134 pips.
If the market fell after both positions were initiated, a 1:1 reward-to-risk profit ($100) would be obtained if the market fell to 1.2832 (1.2966 (average entry level) – 134 pips (your stop)).
Because you entered the majority of your trade at the “better” price of 1.3000, EUR/USD doesn’t have to fall far from the resistance area to make a significant profit. That’s fantastic!