Hi guys, hi from Andrea Unger.
Pyramiding or scaling in, scaling out?
Well, in one of my past videos, I was mentioning how dangerous it was to average down your position.
It was dangerous because you have from a psychological point of view a not acceptance of losses, dangerous because it exposes more and more on a weak underlying, it’s going down and you buy more and more and for many other reasons.
So somebody wrote on my blog: “It’s fine, I like this, but what’s your opinion about scaling in or pyramiding, increasing a position, a winning position.
So here we go
The concept of Pyramiding a position
Pyramiding makes sense in my opinion only if you keep constant control of your risk and if this still lets you make more money netting the positions from commissions costs and so on.
What does this mean?
Imagine that today you enter with one contract and you keep this position for 10 years.
10 years it goes up, up, and you make a lot of money.
If every month you would jump in with another contract, in the end, you would have more money, this is clear because the position went up, but if you entered with the whole sized you distributed along the path at the very beginning, you understand immediately, you will have even more money, because every single contract would have gained the whole move, while scaling in the contracts entering late, obviously, make less money because they aim to a higher level, so they have a smaller distance to travel, but you don’t know from the very start if the move will be that big.
So this is a sort of an anti martingale okay?
Somebody sales this as an anti martingale technique and so on.
Does it make sense?
It makes sense if, first of all, you have these long-lasting position, long horizon, because obviously, you have to take advantage of it.
Imagine that you enter today here and you decide to enter with 1 contract because 1 contract is the size that keeps your losses, in case of stop-loss, below 2% of your equity.
2% is your decision, my decision in this case, okay?
My decision is 2% because my risk profile is telling me that 2% is fine with me, okay!
Now, once your position goes up, it might happen that after 1 month being here, you have this portion of open position profits and this portion of gain could allow you to add 1 more contract, because the new capital you have closed position plus opened position applying still the 2% of risk, would allow you to absorb the stop-loss with 2 contracts instead of 1 because you have more money so you might have a higher exposure.
Consider also that after this move you might have moved your stop loss up, you know I don’t like trailing stop we discussed it, but on such a long time horizon you obviously adjust the stop.
So imagine that the new level of the stop, if I exit here with my contract I would lose only 1% so I could add a second contract because pulling out two contracts would still keep my total losses on the current stand of my equity below 2%.
How do I consider Pyramiding a position?
So keeping the risk profile, the risk of your position at the same level which you define, because of your risk profile, you can scale in and you take maximum advantage of the power of the position sizing.
This is the way to apply it in an open position, while normally you do it when you enter the next position, you close one, you have your closed balance and you make your maths on the following position.
Here you have a long term trend following and obviously, the only thing you can do is to add contacts to your winning position.
You are not entering because you believe in the strength of that market, be careful.
You are entering because your risk profile allows you to do so as you are still keeping your overall risk in that very moment below your risk threshold, in this case, for example, it was 2%.
You have more money, 2% of more is more, in that more you are allowed to risk in case of stop, it allows you to add 1, 2 or whatever contracts to your position.
This is the right way to do it, if you want to do it, in my opinion.
What are the risks of Pyramiding a position?
The Anti-Martingale, which is sold out there, from some mentors is dangerous when it applies to completely absorb your margins and as soon as you have some free margins you add contract because you have more power on your balance, but obviously you have to consider that if you go up with one contract, once you go down with 2 contracts you lose twice as much.
So you have to consider how much you lose when you increase your position and if you just base your decision on margins, you can really wipe out very suddenly and very quickly your account if you increase too much with no specific risk control in your account.
So, I don’t like the Anti-Martingale as is, buy based on margins, but I do consider the increase of a position size based on risk control.
That’s it, you can write your comments about your approach, your knowledge about Anti-Martingale and your thoughts about this approach that I just mentioned.
The scaling out
This scaling out is another technique has nothing to do with this, it’s a technique where you are told to enter the position with multiple contracts and close some at a specific point.
Maybe 3 contracts, one when you cover the costs, another one and breakeven and another one is gain or whatever.
So, this is a purely psychological issue.
I mean, I have nothing against this, but if you do so, let’s say you have 6 contracts, one is closed here, 2 here, 2 here and one here, you have 4 different exit techniques you should do the following: split your system into 4 systems and evaluate the original system with the single exit at a certain point and the sum of the 4 systems, with the same number of contracts obviously, at the different levels.
You will notice that on the average of the overall path of your trading system, the original exit makes you more money.
The bottom line
It might happen at some time scaling out leads you to protect your gains or even to make gains while the original exit could turn into a loss but overall, normally the original and single way to exit brings more money than the scaling out technique.
If scaling out is something you like because you have a good feeling, because you feel fine with it, because you have the feeling to protect your gains or whatever, but let’s say you trade in a more relaxed way knowing that you can scale out, do it!
It doesn’t matter if you make less money, but making a lot of money under a stressful condition might lead you to mistakes or errors which might even be cost full in case you don’t respect your plan.
While, if scaling out is something that makes you feel well, perfect, do it, but don’t think that doing that you make more money just on a plan base, because it’s not like that, normally it is not like this.
It’s something that people tells you to sell you something beautiful, but the beauties are only a psychological aspect behind it.
As I said, I don’t like the Pyramiding technique, buy based on margins, but I do consider the increase of a position size based on risk control.
That’s my opinion, write to me your opinion about this if you have any experience with it and keep in touch.
See you next time ciao from Andrea Unger.