Here’s my favorite way of entering and exiting trades

• September 2, 2005
• Austin Passamonte

When it comes to trading and risk management,
there are numerous tactics to entry, exit and stop-loss orders to decide upon.
Correct trade entries are obviously real important: without them, there is
little opportunity for profit. That said, no money is credited into (or debited
from) an account balance until each trade is closed. We could easily say that
trade exits, not entries are actually the most important aspect of
successful trading.

One approach that is popular for trade
management is multiple contracts entered at once, and scaled out of to exit in
sections. Taking profits in stages may be a valid approach, although it isn’t
one I use myself. We can also make an excellent case for scaling into a position
using multiple contracts to manage risk and maximize leverage in strategic
fashion.

Scaling into a position is less laborious than
one might think. Scaling in has capital exposure at smallest levels when price
action is still moving against us, and largest when markets move in our favor.
It also defeats two of the human weaknesses (fear and greed) that compel us to
over-trade and/or fail to pull the trigger accordingly.

Let’s explore those methods of trade entry/exit
in depth.

Scaling Out

I like to keep things simple. Trading can be complicated and hectic enough
as it is, without my attempts to muck it up even further. I trade multiple
contracts, and they are entered in two stages half-and-half more often than not.
When it comes to exiting a trade, the entire position comes off at once.

Many traders prefer to scale out of a position,
and there are valid reasons for it. I prefer not to, as that actually lessons
leverage of risk/reward unless sustained trade win ratio is very high. For
example, a trade method that uses a -$100 stop and +$200 per contract profit
target will work like crazy with 40% win ratio and no large strings of unbroken
losses. Most intraday traders who use such small stops and targets usually have
a win ratio greater than 50% correct.

Regardless, if we are trading two contracts and
one comes off at +$200 while we let the other one ride, what has that
mathematically done? We initially risked -$100 on two contracts or -$200 total
to begin with. When we took profits at +$200 on a single contract, it is a
breakeven situation with one contract still open. What happens next can greatly
skew the risk-reward ratio of any method.

Will we move our trailed stop to entry or "par"
on the lone contract open? Will we trail it to +$100 instead? If normal market
"noise" happens to take out the second contract at +$100 or par, we essentially
cut our risk-reward ratio way down on that trade.

If instead the market goes to +$400 on that
single contract and we exit there, the average profit size was +$300 per
contract. Beautiful! Question is, how many times will the market move +4pts from
entry as opposed to +2pts and then backwards? A whole new set of variables have
now been introduced to your method of trading.

Would it make more sense to exit both contracts
at $300 instead? Trail stops from -$100 to par or even +$200 along the way? How
many times, what is the percentage of favorable distance covered versus
de-leverage of scaling out from multiple contracts?

Only time, effort, research and diligence can
answer that question for you. I would imagine the answer would be 50% of the
time for each scenario, based on purely random distribution and law of large
numbers. Short-term data bits may give some type of favorable patterns, there
are many variables involved.

Stepping In

These days, most trade methods are based on some type of pull back instead
of breakout. Retracements, extensions, levels, waves and trend lines are all
"the rage" these past few years. In my opinion, methods like that are perfectly
suited for scaling into trade positions. Pure breakout tactics can likewise
benefit much the same.

With any given method or system, directional
market moves offer several buy or sell signals in sequence along the way.
Directional or large-swing moves are where money is easiest made, every time.
Pull back long entries are taken when price action falls into presumed support,
and taken short when price action rises into presumed resistance.

Let me ask you this: have you ever shorted
resistance or bought support only to have the trade stop out for loss
immediately before price action moved sharply in your favor? I have, more than
once. (painful grin)

Likewise, have you ever hesitated to take an
entry signal when price action is moving into a defined signal trigger while
waiting for a "better" price level to be hit? Did you then squirm in your seat
while watching price action turn on a dime and run deep into the profit zone
while you missed the entire move?

If the answer to any of those questions above
is "yes", how did that affect your actions with later trades? Did you wait for
even more perfect signals to avoid getting stopped on a turn? Or did you start
hitting signals "early" in order to not miss out on the next big move again?

Those two acts are labeled fear and
greed accordingly. Fear of loss on a poor entry, or fear of missing a
profitable move (greed) that turns direction before the trade trigger is hit.

Half & Half

Each of those issues can be mostly solved by trading your entire position in
halves. For example, when price action meets the first short signal objective,
take the trade. If it turns and runs straight away without every giving a
continuation signal, what did that accomplish? Why, it got you in for 1/2 a
profitable position instead of missing out on the move entirely. Instead of
feeling negative about missed opportunity, you made money! Totally different
emotional ride and mindset going forward into the session ahead.

Let’s say you take the first short signal and
it reaches the second sell signal while still moving against you. Enter the
second 1/2 position, set its initial stop same distance from that entry as you
did the first. Now what do we have? 1/2 position in danger of being stopped out,
the other 1/2 just coming into play.

Many times price action will turn right there,
work in your favor and give full position leverage with normal stop-loss risked.
Sometimes price action will lift high enough to stop the first 1/2 position out
while the second 1/2 works profitably after price action turns in your favor.
Sometimes price action will keep on rising, stop out both 1/2s and keep on
going. Stick around long enough and you’ll experience everything the market has
to offer.

In any scenario explored above, our initial
stop-loss risk was never greater than the same dollar amount had we entered with
full position at either signal. However, each instance of catching the turn
"just right" was covered as best we could manage. Early turns weren’t missed,
and deeper pull backs had better chance to catch a turn with half or even the
whole position accordingly.

Entering With The Market

Assume we entered 1/2 position short at the first signal, price action turns
right there as we sold the day’s top (it happens… once in awhile) and moves
lower in our favor. We are short 1/2 position and the market is behaving itself
for a change. Now what? 

One of two things will happen. The market will
plunge, we will exit with 1/2 position deeply profitable and await the next
trade setup to come along. or, the market will drop a bit, retrace back up into
another sell signal and we add the second 1/2 position right there. Now what?

Our choices are to blend initial stops to the
amount which is usually risked on a full position, or leave initial stops
staggered just as they were upon entry. I personally prefer the second scenario
from actual experience. Let me explain with the following example:

Each contract is traded with a -$100 to +$250
risk/reward ratio. That balance can be changed in the way we manage stops and
targets from there or into its execution.

When the first short trade is entered, we
expect price action to cease rising and/or turn lower in our favor. Otherwise,
why are we shorting this market to begin with? When the second position is
entered, we can use a combined stop-loss order at 1201.00 to keep initial risk
capped at our usual limit. We can also leave the initial stops where they are
and only blend them when the first stop order is moved to a trailed-stop order
as price action permits.

In my experience, a number of times will see
markets lifting just enough to take out the combined stop before working in our
expected direction. Again, the long-term distribution of that pattern probably
leans toward 50% probable. Personally, I’d rather be taken out of the second 1/2
with a chance to put it back on later than be stopped out of the full position
loss, and then seek new short entries in a falling market.

Once price action moves lower from second
entry, we can trail a combined stop-loss order until the trade is exited. Our
blended profit objective is now 1194.00 (or lower). Our second short entry was
1198.00 level. If price action moves down to 1196.50 or so, we can trail the
combined stop to 1200 for -$100 risked on the entire position while seeking
+$500 profit if 1194 objective is reached.

Fresh Example

Today’s Russell 2000 emini gave an early sell
signal near the 670 level, before the completion of its first 8min chart candle.
Stepping into the trade with a full position risks getting blown out in a
heartbeat. Taking 1/2 position allows limited risk on opportunity to catch an
opening surge move as we often see in this symbol.

Price action dived to 666.80 and I covered that
1/2 on a trailed stop at 667 for +3pts.

The subsequent bounce up to pivot resistance
was another short trade signal, which I took with a 1/2 position again at
668.30. That one worked down to 665+, back to a lower high and short a second
half (full position) at 667.30 with average entry price 667.80. When they took
it down to 663.60 I trailed to 664.80 and got stopped out there in the bounce.
Should have jammed the trail stop at 663.80, but hindsight is always perfect,
now isn’t it?

The midday pop gave no clear long signals in my
method, and I was busy running errands anyway. Failure at 666+ was a sell signal
of sorts, but a 1/2 position there was stopped out at 667.00. Price action
continued to bob around in consolidation while chart signals remained on sell
signal all the way. What to do?

Shorted 666.80 with another 1/2 as last trade
for the day if it loses. That one worked down to a secondary sell signal, add to
the position and trail stops on all contracts at 666.80. Now we have 1/2
position free play, 1/2 position normal risk… full position leverage from
666.30 if it works in our favor.

Down below 664, back up to hit trailed stop at
664.30 and out for +2pts. That is +$300 per 1/2 position (single contract) on
the first short, +$600 per full position (two contract multiples) on the second
short, -$100 on the 1/2 position short from 666.00 stopped at 667.00 for loss
and +$400 per full position on the final trade.

A ten-lot emini position traded in halves would
be +$1,500 first trade, +$3,000 second trade, -$500 third trade and +$2,000
fourth trade. Please do the math for any other combinations of 1/2 position =
full position and leverage remains the same… entering in the direction price
action needs to go is (in my opinion) safer for initial risk and easier on the
central nervous system as well.

Optimized Performance

That’s the way I prefer to maximize leverage while never risking more than a
full position initial stop-loss regardless. I also like to enter the first 1/2
position when first trade signal appears, because many of the good moves only
give one fleeting chance to climb aboard. When markets fail to run away with
reckless abandon and instead plod around, I prefer to stagger the entries and
give best chance for overall profitable results. To each their own, I’m not here
to condone or condemn any trade management tactic as better than another… too
many variables involved on the trade entry side of this equation.

There isn’t a system or method in existence
that doesn’t give multiple entries or exits in directional moves. That is true
regardless of symbol, market or timeframe chart. Spreading out entries greatly
reduces the chance of trades just missed and trades just stopped for max loss
before markets move as expected. I commonly work a sideways market period with
1/2 position long, 1/2 short and 1/2 long for small profit or small loss (worst
case) before the true move is captured in whole.

When scaling into a position, I find that max
stop-loss hits are greatly reduced. Seldom do I get a dual set of buy signals,
lay on a whole position and have it whacked out from there. Don’t get me
wrong… full position stop-outs will always happen. But… the act of stepping
in to a full trade position when markets are moving in favor more often result
in small profits or big ones rather than stopped out, turn and race away.

Most often the trades that stop out for max
loss are ones where we short the first sell signal and then short a higher one
(or buy a higher level and then add to it near deeper "support") and price
action keeps on moving against us. How is that any different a result than
all-in at the lower or higher short signal? It is not… the exact same result
with greater potential chance for one or both 1/2 positions to profit than the
all-in entry offered.

Summation

A trade bought or sold correctly is already half won, to twist an old cliché
from the sales world. However, no money flows into our net until the trades are
closed. Taking profits in harmony with taking losses on average is the key
balance to success or failure in our business. All in and all out can certainly
work fine, and there are some very complex methods of scaling in/out of trades
used by many as well. I prefer a method somewhere in the middle, two-step stages
for entries is my choice.

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Trade To Win

Austin P

austinp@coiledmarkets.com

Austin Passamonte is a full-time
professional trader who specializes in E-mini stock index futures, equity
options and commodity markets.

Mr. Passamonte’s trading approach uses proprietary chart patterns found on an
intraday basis. Austin trades privately in the Finger Lakes region of New York.