A lot goes into building a forex strategy that can produce pips consistently and under a variety of market conditions. Rookie traders have long checklists of issues they need to address before trading for real capital and priority number one should be selecting a trading strategy. Once you nail down that issue, tasks like selecting a broker, a time of day to trade, what currencies to focus on and other issues will seem tame by comparison.
For more seasoned forex traders, strategies evolve and change as the trader gains more experience and attains higher levels of success. With that, we're going to take a look at an element of forex trading strategy that many traders overlook at their own peril: Scaling into and out of a trade. This is not an issue reserved for veteran traders, although it may appear to be just that.
Smart rookie traders will start learning how to scale into and out of a position while they're trading in a demo or simulated account then take those lessons with them to a mini account and on to a standard forex account. Of course, if you trade just one lot on every trade, you don't have to worry about scaling, but we'll assume that at some point your level of comfort with the forex market will grow to the point where you want to trade more lots. After all, more lots can mean more pips.
Let's take a further look at the benefits of scaling into a trade. Let's assume you've opened a standard forex account with 50:1 leverage with $10,000 in initial capital. That means you've got $500,000 to trade with, or you can purchase up to five standard lots at one time. Imagine opening a trade with all of your capital committed to that single trade. Each pip on a standard lot equals $10, so a trade would have to go against you by 1,000 pips to blow out your account, but with five lots, a 200-pip move would decimate your account.
We're not saying you'd allow that to happen. Most traders would get out before absorbing a 200-pip loss, but you see what we're saying. Putting all your ammunition into one trade at one time is stressful. The smart trader scales in, then he scales out as profits are locked in. Let's say you buy one lot of EUR/USD at 1.4566. As the Euro moves up, you see your bullish inclination was right and you buy another lot at 1.4570 and then another at 1.4574 and so on until all five of your lots are occupied.
In an ideal setting, you would be purchasing at higher prices, but only as the Euro moved up, confirming your initial bullishness. So while your average price has moved up, so has your profit potential because you've increased the size of your position. Now it's time to get out, and ideally you would be selling into continued bullishness. You don't sell all five lots at the same time unless there is a strong trend reversal signal.
The smart trader might sell one lot 15 pips in the money, so he locks in $150, then another lot five pips later. There's a quick $350 and that practically guarantees a profitable trade and now you're playing with the house's money. Scaling in reduces your risk profile and scaling out lets your winners run and that's the right way to trade forex.
Scaling into a Trend
The market is dull today, at least as at the time of writing, so again I’m going to step back from the very limited action I am watching on my charts and talk about a technique some of you hopefully will find interesting. I promise it’s more interesting than the title suggests at first glance, anyway!
If you trade trends, or at least if you try to let your winning trades in floating profit run for as long as possible, you will know that one of the keys required to make such a method truly profitable is to not miss a potential trade, in case it is one of the big winners. The most heartbreaking moment for these traders is missing a great trade and watching it take off without being in it. This can lead to revenge trading and various other problems if it causes discipline to break down.
There are two ways traders typically try to avoid this setback: by taking “every trade”, and by “scaling in”, or “pyramiding in” if you prefer. The problem with taking “every trade” is, if you overtrade you reduce or eliminate your profit margin, so it is not a problem that can be solved just by making your entry criteria less selective. Pyramiding in helps, but can also lead to overtrading or position size problems as volatility changes. Maybe there is another solution?
There is something a little out of the box that could be applied – having a trend trading system with an entry definition on every time frame (or at least a graduated range of significantly different time frames, with position sizes broken down and divided equally between them). For example, say you are looking for long EUR/USD trades as you have decided an upwards trend exists in that currency pair. You have an entry strategy that tells you to go long at a break of more than 1.5 time the typical volatility set to some variable on the daily chart. Well, why not apply this also to the hourly, 4 hour, and weekly timeframes, but with a quarter of the full position size on each? This way, an outstandingly good entry will be “fully loaded” and you are unlikely to miss a trend because vagaries on one particular time frame and entry method are unlikely to be replicated across the board.