It's normal for inexperienced traders to want to take profits too early. They do this because they can't see how prices could possibly go any higher. There is also a 'fear factor'. A trader becomes concerned that they might lose whatever gains they might have made. The decision to exit a position early often leads to regret. As soon as they close their position, the market often moves much further and the trader misses out on substantial profits.
To compensate for a trader's urge to exit positions too early, some trading systems teach you to enter a trade with more than one lot and exit half of your position early. You let your profits run with the remaining position.
For example if you bought 1000 shares of xyz company at $40 per share, you might sell 500 shares when price reaches $45. Then with the remaining 500 shares, you could move your hard stop to break even and let your profits run by trailing a stop under price lows, a moving average, ATR stop, dollar value, etc.
Pros and Cons Of Scaling Out of Large Positions
The benefit of doing this is that you can relax knowing that you can't lose after you exit half of your position. Taking some profits early satisfies the urge to lock in profits and moving your stop to break even protects your remaining position from harm - theoretically. (You can still lose substantial amounts of money if your stock gaps down overnight, well below your stop price.)
The problem with large initial positions and scaling out is that you're taking all the risk up front and limiting your profit potential. Basically you can look at entering trades two different ways. You can enter with a large position and scale out. Or you can enter with a small position and scale in as the trade moves in your direction.
Benefits Of Starting With A Small Position and Scaling In.
Your initial risk is smaller
If the trade goes against you, you'll lose less money.
You can add to your position as you make money
You can still move your stop to break even once price moves far enough from your entry point
Let your profits run on your entire position rather than just half of your position
Starting with small positions and scaling in as you make money, maximizes your profit potential and reduces your initial risk |