How to Properly Build a Trading Position
Updated: 2017-10-05 14:18:01What is trading all about? The short answer could be something like “pushing your luck when you're right, and making sure you bail as soon as possible when you're wrong”.
The phrase “pushing you luck” actually has a literal translation in trading: pressing a trade. Over the long run, it's difficult to keep a 70 to 80% batting average. One way to secure yourself some leeway is to maximize your efforts when things are going well, so that you can survive the less than stellar periods. In this article, we shall explore some logical ways to compound a position. It doesn't happen often, but when an asset starts to shift through the gears, it only takes 1 or 2 good trades per year to generate an above average profit.
1. Trading the position vs. trading the trade
“It's not necessarily how – or how many – positions you open, it's what you DO with the position that really counts” - anonymous FX veteran
This is not an article for day traders per se. But maybe it can also help day traders confirm their logic or give them something else to consider. We will be examining a way to press trades: augmenting the position and scaling out partially, in order to remain with a core stake hoping that price continues to honor whatever direction we desire.
Building a position is like building an empire...a block at a time...a battle at a time. Source: empirebuildingkit.com
The term “trading the position” as opposed to “trading the trade” attempts to take the focus away from pinpointing exact entry points (therefore generating a great deal of mental stress) and having a consistent 70 to 80% hit rate. Sure, it can be done and at OrderFlowTrading we have traders that have been holding this average for quite some time. But it isn’t easy.
Also, not all traders are “built” for position trading & position building. Some traders are specialized in going from A to B – period. No questions asked about what the trade might be able to deliver; as long as the trade can get to the initial target then that's good enough for some.
But again, we're not all built the same way. It stems from our beliefs, from our objectives, and many other intangible factors. But today we're going to speak about position building. We're going to speak about 1 precise way of position building...so it's best to go through the “beliefs” that this method is based on:
A) no scaling in. The original entries, from the 1st up to the last position added, must all be based on a proven setup. No averaging into a position here.
B) scaling out. The scale out can be detrimental to your account if not done properly. If you scale out anything less than 2/3 of the position, you are essentially setting yourself up for failure. Let's go through an example.
- We decide to get long EUR/USD at 1.3000 with 3 Mini-Lots (30K).
- Stop loss 1.2970 and first scale out option at 1.3030.
- We scale out 2 Minilots with 30 pips gain, which is equivalent to 48 Euros at current prices.
- The original stop loss remaining on 1 MiniLot is worth 24 Euros. So we make money even if the trade does not allow us to compound.
C) only one entry allowed per day (and there will not be 1 entry every day)
D) we are looking to stay seated and build the position for as long as the market will allow (so we will be rolling over the position, which may be more complicated if trading stocks or futures).
2. Going for the kill
Very few traders are able to compound in a disciplined manner, and then have the guts to stick with the trade. Can you imagine having to sleep through an open aggregate position where each pip can cost you $1000? But before getting to that point, there is a lot of work to do – and a lot of account building to do as well!
Here's where it all starts. You need to have a view of where the market can go. Without a view, you won't know how to compound! Can you compound using a multi-day strategy if your target is 50 pips away? (well ok...50 pips is like 2 days worth of room on EUR/GBP but let's keep things simple for the moment!) Or what if you attempt to micro-compound off the intraday time-frames, when your target is to hold the position for a few days? You would probably overleverage yourself in no time.
So you need to have a view of where the market can logically go, and you also need to focus on your objectives. Like we said in the beginning, the compounding method illustrated here is not for intraday trading. It's used to build positions over many days. But the idea can be used and manipulated to fit your own agenda.
Step 1: get a good view of the market – possibly based on clear sentiment. Source: seattleflyerguy.blogspot.com
How to get a view of the market? At OrderflowTrading we have only 1 answer: Sentiment! Go through the Order Flow Training Program, get a good grip on what Sentiment is and how to read it like a book, and then go out there and attempt to identify securities that are presenting a clear invitation to trade them – i.e. clear sentiment!
Here is a practical example of the best possible scenario: USD/JPY from the end of August 2014 to the beginning of September 2014. The whole process starts with the break of 102.60 which was an important stop loss level very frequently touted on the trading floor.
The first opportunity for a long position came on the 19th of August at 102.65 and gave the opportunity to scale out 2/3 at 103.10. Stop loss was at 102.50.
The second possible entry came on the 22nd of August at 103.67 and gave the opportunity to scale out 2/3 at 104.00. Stop loss on the original 1/3 + this second position was brought to 103.45.
The full view of the UsdJpy opportunity. 5 entries in the space of 3 weeks. The best possible outcome with no stop outs. Source: FXCM Marketscope
So long as price continues to honour the stong sentiment with which we are aligning ourselves, prior swing points do not get compromised and no prior stop loss gets hit. The end situation on the UsdJpy compound looks like so:
UsdJpy final situation after the compounding shown above. Source: FXCM Marketscope
3. Dealing with false starts
The logical question, at this point, is to ask: what happens if we get a lot of false starts?
Good question, love where your head is, and here's the answer:
You never know when it's going to be a false start! But if you trade only when you are able to identify strong sentiment, you will greatly reduce the amount of false starts you receive.
Part of the whole trading gig is to act like a sniper and not a machine-gunner. Play when the odds are in your favor. Don't play every day and be sure not to play multiple times a day! If you can reduce the amount of errors in your trading, your bottom line will improve automatically.
But let's go and analyze the Euro since Mr. Draghi hinted at a new round of QE for the Eurozone.
If anyone has told you it's been an easy trade, they're lying. The Euro has had a choppy descent.
First attempts to build on the Euro. Source: FXCM Marketscope
And here is another example on the choppy euro. The key, after being stopped out, is to re-assess and wait until there is clear sentiment to participate once again.
Source: FXCM Marketscope
So as you can see, it doesn't take long to create a large solid position, taking adequate risks on each entry and not pushing the letter. The main secrets of this compounding process, which we could actually call risk-management secrets, are:
1) trading only when there is clear sentiment – and if you don't have a good read on sentiment, go study the Training Program and you'll learn everything there is to learn about it.
2) Trade like a sniper: do not look for trades, let them come to you. Only look to compound entries when in fact there are valid setups appearing. Otherwise you'll only end up compounding a pile of rubbish.
3) Be patient and let the market tell you when enough is enough. The USD/JPY trade example was a great opportunity.
4) There is no “one size fits all” in trading, so don't try to trade like this just because it looks good. There are traders that would never trade like this. So don't force this upon yourself if it's just not your thing.
To sum up: compounding can be a great way to maximize a strong, sentiment-driven market. By adding positions as the market continues to shift through the gears, you create a heavier position and get more bang for your buck. It doesn't take many additional positions to make a killing out of a week-long trend. Even better if the trend continues! But of course, each trading method has it's drawbacks. In particular, scaling out 2/3 of the position at the first evident trouble zone (which should be at least 1R away from entry) dilutes profit potential in choppy markets. But then, this method is suited for markets guided by strong sentiment, so make sure you study the Order Flow Training Program and know how to identify a strong sentiment shift when you see it!
Good Luck!