Greetings, and welcome to the last post in my series on trading tactics!
Trade management is what you do between the time you decide on a position to the point at which you exit the position. It includes the issues of where to get in, whether to go all in at once or to scale in gradually, where to get out, and whether to scale out or not. Since trade management involves position sizing and exit strategies, it actually includes the idea of risk management, as well as “profit management.”
Below, I’ll go over my own principles of trade management and provide some examples of how I manage a position from start to finish. As always, these techniques may not be suitable for every trader, so construct your own trade management strategy according to what works best for you.
A common question among traders on many discussion forums is whether entries or exits are more important to success. In my view, there’s really no essential distinction between the two. Take a look at the diagram on the left. See the symmetry there? An entry into a long or short position is simply an exit from a flat position, and an exit from a long or short is just an entry into a flat position.
“But wait,” I hear you protest. “They aren’t the same with respect to risk! An entry involves taking on more risk, while an exit involves reducing risk. So there, smarty-pants!”
Well, let’s see. Reducing risk sounds a lot better than increasing risk, so why don’t we do that all the time? In other words, why don’t all traders just close all their trades, and eliminate risk altogether? Because by doing so, they’d be foregoing any possibility of future profits, that’s why. In effect, they’d be increasing their risk of missing out. Looking at it in this larger context, we see that going flat involves risk just like entering a long or short position does.
So again, there’s essentially no real difference between entries and exits. They’re equally important, and the same strategies and techniques can be applied equally to each. That’s in theory of course. In practice, there’s at least one exception that I’ll discuss below when we get to the subject of scaling in and out of a position.
“Cut losses short and let profits run.” Next to “The trend is your friend” this is probably the most often quoted piece of common trading wisdom out there. But many traders manage their positions by setting both a stop and a take-profit (TP) point right at the outset. This addresses the part about cutting losses short, but how does this let your profits run, exactly?
The answer is that it doesn’t. This is why I don’t use TP points to manage positions. The way to let profits run is to trail your stop behind the price as it moves further into profitable territory. This gives you an open-ended profit potential on every trade. While most will just get stopped out with average profits or losses, a few will bring you more pips than you ever thought possible when you first entered the position. These are the trades that make your month or year worthwhile.
In the last section I made the point that there is usually no distinction between entries and exits. One of my “aha moments” in trading came when I realized that if trailing orders made sense for exits (as in the case of stops) then they make perfect sense for entries too. Take a look at the chart of EUR/JPY below.
Here, I’m trailing a short entry order behind the price as it drifts upwards. As I continue to trail my entry order, I’m ensuring myself a better and better price at which to sell when price finally turns down and triggers my order. This is how I always make my initial entry into a position. I never just buy or sell at the market.
Scaling in and out
Most traders don’t delude themselves into thinking that they can always (or ever) pick the best entry price. That’s the point of scaling into a trade. By entering only a portion of your ultimate position size at first, you can then see how the trade develops and decide whether to put on the rest of the trade or not.
As I described in the last section, I trail an entry order behind the price if it’s not moving in my direction. The initial order size is a function of my Kelly criterion value and the distance to my (very) wide stop. You can review these calculations in my last post on risk management. I size my subsequent entries, using the same Kelly value, rounded to the nearest 10%. For instance, if my Kelly value is currently 53%, I would increase my position size by 50% with each subsequent entry.
I place each subsequent order beyond a technical support or resistance level in the profitable direction. So if I’m long, for example, I would identify a resistance point above my initial entry, and place my next entry above that point. This way, I’m generally adding to my position as it moves further into profit. However, if price turns against me, I would continue to trail the order behind the price (even into losing territory) in order to get a more advantageous price. Take a look below at my long trade in AUD/CAD for an example of adding to a winning position.
But what about scaling out? Since I claim that there is little or no distinction between entries and exits, I should treat them the same, right? Which would mean that logically, I should scale out of my trades too. However, here’s where the exception comes in that I mentioned in that section. The reason that I don’t scale out of trades is that it creates a practical accounting issue in determining the profit or loss on the position.
Entering a position doesn’t have any effect on the cash balance in my account, so I can break my entry up into separate pieces. However, exiting a trade causes the cash balance to change by the profit or loss of the exit. In order for me to easily see the profit or loss from my entire position, I need to close it out all at once. That way I can just compare my cash balance before the exit to the balance after the closing trade to find the profit or loss. Closing the trade out in pieces would require me to keep track of the profit or loss of each individual exit, which would be quite a pain. So that’s why I don’t scale out, only in.
Averaging up vs. down
Another piece of common wisdom among traders is that you should never average down; only up. So according to this, you should only add to winning trades, and never add to losers.
I have a different view of this. The market doesn’t know where you entered the trade, and doesn’t care if you’re profitable or not. So this shouldn’t be the determining factor in whether you make a trade. For me, my analysis is king. If my indicators say that the pair I’m trading is bearish, then I’m a seller. It doesn’t matter to me if price is above or below my initial entry.
Remember the chart of EUR/JPY above, where I was trailing a short entry order behind the price as it drifted higher? Let’s look at the zoomed-out version of that trade below.
What?! Hey, that trade’s a loser! That’s right. My initial entry area for that trade was way down around 124, while the price is now in the 130 area. But my weekly analysis still shows a bearish outlook for this pair, so I’m still a seller. That’s why I continue to trail a sell order behind the rising price. If price turns downward and fills the order, my average entry price will rise, and the pair will be heading back in its direction.
In order to reduce risk in situations like this, I reduce my subsequent entries to only about 1/4 of the current Kelly percentage (again, rounded to the nearest 10% for practicality). So in this case, since my Kelly value is 53%, I’m not adding 50% to the position with these averaging down trades; I’m only adding about 10% on each subsequent entry.
So what happens if my analysis changes next week, and EUR/JPY is no longer showing a bearish outlook? In every case in which that happens, regardless of whether the position is in profit or loss, I always do the same thing. I tighten up the wide stop order, and trail it aggressively behind the price. In many cases, I’ve seen the pair continue to move in my original direction even after the analysis changes. That’s because the analysis tends to lead price by several weeks. So even in cases where the analysis changes before my position is in profit, I still often find myself trailing the stop into profitable territory.
Trade management summary
So here’s my basic procedure for managing a trade.
- Determine the initial position size. I detailed this process in my last post on risk management.
- Trail the initial entry order. If the analysis changes before it fills, then I just cancel it.
- Pick the next entry point. Once the initial order fills, I pick a spot further in the profitable direction for the next entry. This is generally behind some technical support or resistance point. If it’s in profitable territory, I use my current Kelly value as the percentage to add. If not, I use 1/4 the Kelly value. If price advances and fills the order, then I just repeat the process. If price goes against me, then I just trail the entry order behind the price until price turns around and fills it.
- Wash, rinse, repeat. I continue in this way until my weekly analysis of the pair changes. At that point, I tighten the stop order and trail it behind the price until it’s hit.
Well, that finishes off this series. Now, in order to implement all this in your own trading, check out the CapTraderPro dashboard.
I’ll see you there, and as always…keep pipping up!
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