Scaling-In Trading
I’ve been getting lots of e-mails from subscribers asking about position sizing, unit sizes, scaling-in strategies, and stops. I could literally write a short book on this as it’s fairly vast. Over the next four days though, I’m going to attempt to cover most of these topics in order for you to learn more about how I see each.
Today, we’ll go slow and discuss what a unit is and how to scale-in.
Ideally, you’ll scale-into a position in multiple units. For example, if you have allocated $10,000 to a position ahead of time, instead of buying or shorting all $10,000 at once, you will look to “average in” over a few days period of time. Let’s say that you’ll do this in 3 equal units. This means today you’ll buy 1/3 of your position.
Tomorrow (or any day you’re still in the initial position), if prices close lower you will buy the next 1/3. And then if at anytime you’re in the second unit of the position and prices close even lower, you’ll add your final unit.
At the end of this scaling-in process you still have your original $10,000 invested. But, your average cost is lower.
Here are the advantages of trading this way:
Quite often, your probability of success increases (sometime significantly) because you bought your security lower. We’ve seen many cases in our testing where this type of trading has taken ETF trading into the high 80’s on a percent correct basis and in some cases (on the SPY) to above 95% correct in testing all the way back to 1993. These are very good returns.
On the downside, if the first unit you buy nails the bottom (or top for shorts), you only had 1/3 of a position instead of a full position. This is the price one pays when scaling-in: you make less if you’re right early on.
For us, most of our ETF trading has moved to scaling-in. We feel it’s a far superior way to trade ETFs (and based upon our latest testing, we may be doing the same for our equity trading too, as it has the same advantages).
The key thing here is for you to decide: do you go “all-in on the first signal? Or do you “scale-in” with the goal of lowering your cost basis and potentially increasing your percent correct? This decision is up to you, but based upon how I look at markets (especially ETFs), the scaling-in process is superior for “high probability trading.”
Tomorrow, I’ll go further.
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Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.