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Follow these two rules to preserve and grow capital
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Follow these two rules to preserve and grow capital

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Follow these two rules to preserve and grow capital

Based on my own experience and failings, I've formally adopted two rules:

  1. Never add to a loser, EVER. EVER. If adding to a winner, close the position if the market moves to your average entry price (your breakeven point), and only add above (if long, below if short) your previous add.
  2. Don't take more than 3 losing trades in a 15 minute period, and 10 trades in a 2 hour period (adding to a winner doesn't count as a trade; a 1 tick or greater loss does count).
Rule 1 prevents death by nuclear explosion.
Rule 2 prevents death by a thousand cuts.

The premise behind these two rules:
  1. Rule 1: If you add to a loser, you're throwing money at an idea which has, thus far, not worked. Make the market prove to you that your idea is working. Otherwise, you run the risk wanting the trade to work (which you never should want; instead, you want total objectivity with no particular bias towards the long or short side) and losing your objectivity.
  2. Rule 2: If you take this many trades, even if they are tiny losses, chances are that you are not in tune with the market, and are likely in fear of missing some move you think is coming.
When you're wrong, rule #1 makes it impossible to be "more wrong," so you can only be "wrong small"; it also promotes being "right big."
When you're wrong, rule #2 makes it impossible to accumulate many small losses due to taking too many impulsive trades in an attempt to not "miss the move" and promotes a patient attitude.

I'm not really a big fan of rules surrounding which trades to take, and when to exit those trades, as my approach to markets isn't too quantitative. But when it comes to position and risk management, the above 2 rules are really a must for me.

By following the rules above, the follow gut-wrenching scenarios are prevented:
  • You try to buy every dip in a falling market, and you're down 100 ticks as it bottoms; however, you realize that it's only down 60 ticks from where you initially bought; through a combination of adding and overtrading, you have lost twice as much as you would have lost by simply buying one and holding it. Or worse, you've only added and are now massively long at the lows.
  • You try to catch a breakout but chop yourself up in a range of consolidation; you lose 40 ticks while it consolidates because you keep jumping in and out, losing a tick here and there, and realize that you now need a pretty big move from the breakout just to get back to even. Worse, upon realizing this, you then add size, the breakout fails, and you wind up losing even more.
Chime in with your own risk management rules if you like, or feel free to discuss these.


Last edited by josh; March 3rd, 2018 at 01:38 PM.
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josh View Post
Based on my own experience and failings, I've formally adopted two rules:

  1. Never add to a loser, EVER. EVER. If adding to a winner, close the position if the market moves to your average entry price (your breakeven point), and only add above (if long, below if short) your previous add.
  2. Don't take more than 3 losing trades in a 15 minute period, and 10 trades in a 2 hour period (adding to a winner doesn't count as a trade; a 1 tick or greater loss does count).
Rule 1 prevents death by nuclear explosion.
Rule 2 prevents death by a thousand cuts.

@josh,

There's a lot to be said for both of these rules. Just a couple of comments on each:

Rule 1: I follow this one religiously. However, I recall both Mike and Gary in the old days of the spoos thread "scaling in" -- adding to positions that were going against them because they would improve their average cost basis, and they were willing to be wrong if it came to that (they would bail quickly if they found they were wrong.) They were right often enough to make it work. I never understood how to do this, and obviously it takes deep, deep pockets -- and if you're wrong very often or very big you're in deep trouble -- but some people can do it.

I'm not one, but it's not necessarily a universal thing. (Note: "Gary" is Tigertrader, for the non-OG's. )

Rule 2: Everyone should have some loss-control rule or rules that they never let themselves violate, even at the highest point of "I've got to make it back" insanity.

I have something similar. My trading involves trend following, in part, so I am subject to whipsaws if I judge the situation wrong and the market just goes up and down in a small range. My rule is that after two whipsaws in a row, I'm done. I can go back in after an hour, but usually I just stop for the day. There's something wrong with my read of the market, and I can't rely on it now -- better to fold.

I think that everyone should have some hard rules to prevent both the "nuclear explosion" and the "thousand cuts" outcomes. Even if scaling in, a trader will have to stop the process at a certain point if the trade isn't working, so you need a way to judge that, if you don't just use "it's going against me" as the criterion.

Exactly what rules to use will depend somewhat on both a person's trading style and self-knowledge. For instance, I know that if I permit myself to scale in, I will end up at the bottom of a deep, deep well, so I simply won't.

Bob.

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bobwest View Post
Rule 1: I follow this one religiously. However, I recall both Mike and Gary in the old days of the spoos thread "scaling in" -- adding to positions that were going against them because they would improve their average cost basis, and they were willing to be wrong if it came to that (they would bail quickly if they found they were wrong.) They were right often enough to make it work. I never understood how to do this, and obviously it takes deep, deep pockets -- and if you're wrong very often or very big you're in deep trouble -- but some people can do it.

I'm not one, but it's not necessarily a universal thing. (Note: "Gary" is Tigertrader, for the non-OG's. )

...I know that if I permit myself to scale in, I will end up at the bottom of a deep, deep well, so I simply won't.

IMO the only really good reason to scale in is if the trader is throwing size that actually would have an observable market impact. Even Gary was not that big in ES.

The logic goes like this for me: if the zone that one wants to scale in over is X ticks wide, then certainly the target is at least 4X away or so, right? With a target that is sufficiently far away, whether one adds on the way down or on the way up won't make that much difference.

What usually happens when people scale in, from what I've seen and my own experience, is that when it does actually begin to work (the market looks ready to actually move their way), they are still able to buy at prices equal to or better than the initial ones they bought at. For example, they buy 2700, then 2698, then 2695, then 2690. It pops to 2696, finally starting to look good; meanwhile, their average is only 2695.75 -- so, they could just buy now, and still be in at roughly the same price, without having incurred the risk.

Of course, the other scenario is that they begin to scale in and it goes their way, and they at least have something on at smaller size at a better price than they would have if they waited until higher prices to buy. But, they're still small, and if they want to be bigger, they'll have to pay up anyway.

Either way, I think too many people use scaling in as an excuse to get sloppy and early with entries. Also, I think it makes it more difficult to add later, as it places the emphasis on "getting in early." Some of the absolute best trades are the ones where the market has already tipped its hand a bit, and an explosion is imminent; adding on the way up (or down) in these cases is the only way to get in with size, and they're the best trades to be in because you will often take no heat at all.

The above two rules are not meant to be universal, but IMO any trader who is in the "capital preservation" stage, or early enough in the "capital growth" stage would benefit simply from never adding to a trade which is not in the black.

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josh View Post
I think too many people use scaling in as an excuse to get sloppy and early with entries. Also, I think it makes it more difficult to add later, as it places the emphasis on "getting in early."

@josh, thanks for this, I feel like I'm currently on this path and I know eventually it will come around to bite me hard. I'm constantly battling entering too early; I usually have the right idea but always seem to manage to pull the trigger too quickly. One thing I have been doing is going in with just one contract when I have this impulse, and then trying to wait longer and see what unfolds. I'm convinced it's tied to FOMO. I don't chase price if it moves away from me, but getting in early is essentially the same thing.

Do you have any tips or advice for honing the entry skill set?

Thanks
Shane

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josh View Post
IMO the only really good reason to scale in is if the trader is throwing size that actually would have an observable market impact. Even Gary was not that big in ES.

The logic goes like this for me: if the zone that one wants to scale in over is X ticks wide, then certainly the target is at least 4X away or so, right? With a target that is sufficiently far away, whether one adds on the way down or on the way up won't make that much difference.

What usually happens when people scale in, from what I've seen and my own experience, is that when it does actually begin to work (the market looks ready to actually move their way), they are still able to buy at prices equal to or better than the initial ones they bought at. For example, they buy 2700, then 2698, then 2695, then 2690. It pops to 2696, finally starting to look good; meanwhile, their average is only 2695.75 -- so, they could just buy now, and still be in at roughly the same price, without having incurred the risk.

Of course, the other scenario is that they begin to scale in and it goes their way, and they at least have something on at smaller size at a better price than they would have if they waited until higher prices to buy. But, they're still small, and if they want to be bigger, they'll have to pay up anyway.

Either way, I think too many people use scaling in as an excuse to get sloppy and early with entries. Also, I think it makes it more difficult to add later, as it places the emphasis on "getting in early." Some of the absolute best trades are the ones where the market has already tipped its hand a bit, and an explosion is imminent; adding on the way up (or down) in these cases is the only way to get in with size, and they're the best trades to be in because you will often take no heat at all.

The above two rules are not meant to be universal, but IMO any trader who is in the "capital preservation" stage, or early enough in the "capital growth" stage would benefit simply from never adding to a trade which is not in the black.

It's clear that these rules are the result of tough lessons that have left you wiser but also more humble (a top notch human quality if you ask me). Because of this and the humility you are writing with I have been giving much thought to what you are saying and trying to factor it into my trading plan. I'm still wrestling with it as my current plan has me scaling in at a couple of different predetermined levels but I've noticed there is definitely a point where I get the feeling that "this is now requiring an abundance of hope" which never works out well. I am grateful for you sharing your hard earned lessons here...and happy to learn from them.
Craig

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bobwest View Post
@josh,

There's a lot to be said for both of these rules. Just a couple of comments on each:

Rule 1: I follow this one religiously. However, I recall both Mike and Gary in the old days of the spoos thread "scaling in" -- adding to positions that were going against them because they would improve their average cost basis, and they were willing to be wrong if it came to that (they would bail quickly if they found they were wrong.) They were right often enough to make it work. I never understood how to do this, and obviously it takes deep, deep pockets -- and if you're wrong very often or very big you're in deep trouble -- but some people can do it.

I'm not one, but it's not necessarily a universal thing. (Note: "Gary" is Tigertrader, for the non-OG's. )

Rule 2: Everyone should have some loss-control rule or rules that they never let themselves violate, even at the highest point of "I've got to make it back" insanity.

I have something similar. My trading involves trend following, in part, so I am subject to whipsaws if I judge the situation wrong and the market just goes up and down in a small range. My rule is that after two whipsaws in a row, I'm done. I can go back in after an hour, but usually I just stop for the day. There's something wrong with my read of the market, and I can't rely on it now -- better to fold.

I think that everyone should have some hard rules to prevent both the "nuclear explosion" and the "thousand cuts" outcomes. Even if scaling in, a trader will have to stop the process at a certain point if the trade isn't working, so you need a way to judge that, if you don't just use "it's going against me" as the criterion.

Exactly what rules to use will depend somewhat on both a person's trading style and self-knowledge. For instance, I know that if I permit myself to scale in, I will end up at the bottom of a deep, deep well, so I simply won't.

Bob.

Bob, I agree with your whipsaw principle. Sometimes an idea is still good and you just gotta take another swing at it. If thats wrong, then absolutely, walk away for a bit and find another setup. Your judgment is going to be too clouded after two failed attempts.

I used to only allow one attempt but observed (no hard data) that I was just a bit early sometimes. Particularly true if youre trading pullbacks - perhaps the test you saw didnt quite blow off enough steam yet. Theres probably a deeper rooted FOMO and patience issue here, but alas...

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josh View Post
IMO the only really good reason to scale in is if the trader is throwing size that actually would have an observable market impact. Even Gary was not that big in ES.

The logic goes like this for me: if the zone that one wants to scale in over is X ticks wide, then certainly the target is at least 4X away or so, right? With a target that is sufficiently far away, whether one adds on the way down or on the way up won't make that much difference.


Either way, I think too many people use scaling in as an excuse to get sloppy and early with entries. Also, I think it makes it more difficult to add later, as it places the emphasis on "getting in early." Some of the absolute best trades are the ones where the market has already tipped its hand a bit, and an explosion is imminent; adding on the way up (or down) in these cases is the only way to get in with size, and they're the best trades to be in because you will often take no heat at all.

Josh, I love that you've brought this up. To preface this discussion, I mean no offense to Gary or Mike or Ed (Inletcap) or any of the other traders who successfully press their edge around zones of interest. In many ways, I can see the validity of this point. You can fade a zone, scalp a few ticks here and there while keeping a couple of contracts on, and see if it goes big time for you. If it doesn't, you made ticks scalping and lost a few ticks on the ultimate failure of the fade. Over time, it's probably a positive expectancy in a good trader's hands.

I used to do this in my own trading and I found that it just didn't work for me.

Like you mention, it allows novice traders to get sloppy with entries. Why bother picking your spot, waiting for your spot, and executing, when you can just "scale in" later? This is what I would always do:

1) Pick a spot. If the ES is 2010, I'll bid something like 2005 and tell myself that I'll scale in, because "It'll hold above 2000".

2) The market cracks right through my initial buy at 2005. I tell myself "Good, now that gives me an opportunity to scale in and put more size on". I buy another at 2003--because if it was a good buy at 2005, it's gotta be amazing at 2003!--and say "Now that I'm scaling in, I should give this a little room. I'll stop out at 1998.50".

3) The market trades 2000.50. I'm now down around 4 handles on much larger size than I should have on, and there's no sign of stopping. I buy again at 2000 because "This will be the spot where it finally works".

4) The ever-fickle ES snaps through lows, stops me out, and then trades back to 2005.

Here are the issues with what I was doing and what (I anticipate) I should have done.

1) I arbitrarily decided to buy too early. If I thought the market was going to 2000, why risk 5 handles on that? I should have considered buying lower. Furthermore, if I really saw buyers absorbing around 2005, I can crack off a quick scalp to see if it trades back to 2006 or 7, and then I exit that long. The ES in particular is whippy--hell, most of the products traded on this whole forum are thin and whippy--and if I can get four to six ticks out of a quick scalp, I'll take em. If 2005 is really the stopping point, the ES will likely revisit 2005.75 at the least, and I can get back in there. I don't really have stats on this. This is pretty much just based in the amount of time I've spent trading that product. It likes to revisit prices.

2) I would have no plan for scaling into the trade. I'd tell myself "I'll scale", but not know how much size where or when. And, fundamentally, I wouldn't understand the context behind whether or not the scale in is a valid trade. What if the ES plummeted 10 handles out of nowhere? What if the ES slowly grinded down throughout the day and was consistently rotating four to six ticks? I would have mistakenly traded the two situations in an identical fashion, which is the wrong approach to have.

3) ES at 2000 means that my long from 2005 is dead wrong. Unless I'm looking for 1950 or 2050 in the trade, 5 handles of heat pretty much means you should have been flat long ago. Perhaps 2000 is the stopping point! If it is, like Josh says, there are plenty of opportunities to buy 2000 and sell 2001.25 as the market consolidates. If 2000 is your level to buy, you could buy 2 at 2000, sell 1 at 2000.75, buy 2 at 2000.25, scratch 1 at 2000, buy 2 at 1999.75, and then see what happens. You're long 4 at 2000 and the market is 2000 bid. But, because you "campaigned the position", you have 2 ticks in the bank and now you have a position built. You have a little money. You have some size. But most importantly, you have knowledge! You know what kind of auction you're seeing at 2000, and you know very quickly whether you want to keep the long or scratch it out--or even flip and join the sellers pushing to break lower.

4) The ES snaps to 1998.50. You're long 4 at 2000, looking at 6 ticks of heat. If you scaled in the whole way down, buying 2005, 2003, 2000, you're now looking at 50 ticks of heat. It's a whole lot easier to breathe when you are only down $75 (and up $25 from the initial scalps) instead of $625.

Overall, I think the theme is knowing your market. Know what price you want to get involved at, know what price action you want to see at the level before the market gets there, and don't just throw limit orders into the book right when the market opens. See what happens at the price. See what the auction is like, see how money is moving the market, see if your thesis is correct, and then decide whether or not you want to scale into a position.

FWIW, I don't scale into positions. I don't really do position daytrading; I look for a few ticks here and there in the treasuries, instead of creating an overall idea for the day type and building a position throughout the day.

If you're a newbie, I think that scaling in will hurt your bottom line and your learning curve. If you're experienced, you don't need my advice!

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Rrrracer View Post
Do you have any tips or advice for honing the entry skill set?

Maybe this: just like in a negotiation, your greatest asset is your ability to walk away. If a move is truly a good move, you can always get in after it gets going. You won't miss out. No need to FOMO. Very general, and I just erased a whole paragraph dealing with liquidity, etc., but what's really important is that when you see what you want to see, get in without thinking too much. If it doesn't look that appealing, just don't sweat it.


Rrrracer View Post
I don't chase price if it moves away from me

I'd cautiously add that it's usually better to chase a move that's in progress (and still has energy) than to wait for all the stops to go, all the momentum to die, and the market to calm down, and then patiently buy a pullback. Sometimes we go all "deer in the headlights" when the market starts to move, but that's the time to act decisively, and then assess whether it's working, rather than wait for it to go up 70 ticks and THEN decide, "oh yeah, I think I'll buy."


Last edited by josh; March 5th, 2018 at 09:42 PM.
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lax99 View Post
If I thought the market was going to 2000, why risk 5 handles on that? I should have considered buying lower.

Somewhere on the spoos thread, the ever-wise Gary threw some logic at me once that went something like this.

Me: "Hey Gary, I want to buy it at 2000. What do you think?"
Gary: "It's trading 2015 -- if you really think it's going to 2000, why aren't you short?"

It speaks to how I tended to have difficulty going with the flow. If the market's making new lows by the minute, why am I not short? The market is throwing out easy $10 bills. Why am I pushing away a hundred $10 bills, trying to catch the one $100 bill that I think might be coming?

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