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Pro's and Con's: Adding to losers / Dollar Cost Averaging
As @bobwest said, It's definitely a good strategy, but I think it's difficult to understand in which circumstances this can be done and how. It's definitely not something for beginners.
I think the most common made mistake is that traders scale-in out of frustration of their losing position. They scale in against a trend which is like trying to stop a freight trein with piling little pieces of wood and throwing them in front of the train. They occasionally get out with a very small profit and they're happy they got out of the day break-even. Other times they hit a catastrophic loss cause the market just kept going and they can wipe out a significant part of their account in just one day simply because they didn't take their loss recognizing a trend was in effect. (Sure everyone understands how I know this )
I personally scale in a lot on Bund and to lesser extent on the ES. For me there are two types of scaling in and they're totally different in how to manage:
Trend days:
On a trend day, when you have a big breakout, I usually enter on the close of a big breakout bar and then scale-in if we get a pullback. If there is no pullback and the market keeps racing I have a smaller position but a larger target. Eventually there will be a pullback and I'll decide to enter then yes or no depending on the price action.
I don't really see this really as scaling-in but more as a form of swinging and scalping cause my stop for the swing is in a different place than the add-on scalp.
Trading range days:
These are the real days made for Scaling-in and taking tiny little scalps instead of swings. Trading range days are very common especially lately on the ES. Often you'll see a move with big tails on the bars, overlapping bars and you're confused about the direction of the market. Trading ranges often have two-legged moves and wedges. Upon the end of a two-legged move and especially if I see like 3 or more gaps below, if there is a good signal bar in the opposite direction I think traders enter with the intention of scaling-in more if the move goes further against them. When price does move higher and comes back to their original entry, they take a profit on their second or third entries and break-even on their first. If I enter, my targets are always towards those scale-in positions, previous highs and lows, the open of the day and mini gaps closing.
This price action, if you pay attention to it shows this very clearly on for example ES but it's even more clear on the Bund.
There's so many difficulties though with this strategy that make it very hard to do:
Thinking something is a trading range while in fact it's trending
A trading range where you scale in which suddenly breaks out into a trend hence you got to get out with a (big) loss and now trade the trend.
A scale-in position that isn't reached on the day (sometimes it reaches the target on the next day which is really difficult for an intraday trader like me that is flat at EOD).
Where to put a stop, where to put a TP.
How to structure trades such that they have a good risk/reward.
How to determine where traders are getting out (1R or 2R?)
I think, in general, I don't recommend scaling in to losing positions but you do have to have awareness of the fact that other traders might have scaled-in and are hunting a potential target, that can keep you in a trade longer or shorter avoiding losses.
Hope my two cents can provide some food for thought.
Thanks @Rrrracer - Another thing worth adding: I always look at whether the trend traders have exited when I consider a countertrend trade. For example, if a market runs up and then suddenly has a big bear bar or bear leg I don't short immediately there cause I know bulls are still in. However these bulls will get scared and try to exit at the last bull close of the run up. If the market then turns there again I know bulls are out and bears are in, so that's when I enter countertrend (only in trading ranges, never in trends).
About scaling in when price goes against you, in my opinion, the debate about doing it or not is much like many other debates in trading: it is all a matter of experience.
Should a person that is not really sure about what's going on in the market double down? Of course not. The very definition of doubling down is one of determination. Determination is good when you know what you're doing, or at least when you have a pretty good idea. But determination for determination's sake is pointless and in trading it's the fast lane to ruin.
But a person whose trading development is at a state where they can tell about price action; where they see what price is attempting to do; when they know when a given level has been broken, or not (or whether there are attemtps to break it); where they understand their market fairly well; when they understand context; when they can tell when having a bias is appropriate, what the bias should be and whether they think their bias is still correct, then yes, they could think about incorporating the scaling-in concept in their trading strategy.
Never worked for me. If the first trade goes bad and the entry was based on your normal probability of success, how do you assess the probability of subsequent trades based on the same logic? I bet that if it could be tested across a broad spectrum of traders, that the probability of success would go down with each trade that adds to the loser. It's like throwing mud at a wall and hoping some will stick.
Your poll question on adding to positions seems to only account for growth and/or trend strategies. If one has long term holdings in a solid company collecting dividends and price drops improving yield and fundamentals of company are still solid then adding to positions to bring down cost per share and improve yield is quite good.
This is turning out to be an interesting thread. Many (or most) people basically look at scaling into a losing trade with disbelief and incomprehension, and most (I am one) have no interest in trying something that has lost them money many times in the past. But then, why does anyone who is not either a rank beginner or essentially crazy ever do it? Hmmm.... must be a reason.
Inquiring minds want to know.
Let me put down a couple of thoughts based on what Ed ( @Inletcap) did in his trading when he was active here. He was sort of an extreme case of a scaler-inner, more so than almost any others. This is just my own take on what he did, and I'm not offering it either as what anyone should do, nor even as necessarily what Ed did, although I think it is pretty accurate as a summary of his trading. I watched him develop as a trader and we went back and forth often while he was posting trades (he would post and do updates several times a day), so it's probably at least somewhat right.
For starters, he would formulate a "thesis" -- which was not necessarily anything more than a decision about how he would initially trade. He was pretty loose about this. He told me many times that his big breakthrough as a trader came when he realized that he could make any trade he wanted to and still make money. (Bear with me, this will start to make sense -- I hope .)
His thesis would have something to do with levels that he thought were important (floor pivots, opening range, VWAP, that kind of thing) as well as relative volume, what price was doing, and other stuff. He would use these factors but would not necessarily try to deduce what the market would do based on them. He wanted to get into a position that was somewhat reasonable and then manage it aggressively by both scaling in and scaling out, based on what it did. He would have a clear idea of when he would have to give up the thesis because price had just not borne it out, and he would have multiple targets (based on those levels) where he would take partial or full profits.
After that, he would just trade the hell out of it so long as his thesis stayed valid. He would scale in when price went against him (down to his bail-out level) and would very often take partial profits when he had them, and would definitely add when the move was strong.
For instance, he might be long, add to the longs as price declined (which improved his basis -- average cost), and then sell a few contracts if it turned up a bit, especially if some contracts had gone into a profit, cutting his loss and perhaps going net positive. If price went in his favor, he might scaleout a few contracts, buy some back in on a pullback, and/or scale in as it went in his favor to maximize his return. And he did this all day long. This inning and outing let him move his average cost up and down, minimizing the damage when price was against him, pushing hard when it went with him, and taking partial profits often.
You might say something like, "Well, if you're going to be in and out all the time and you're any good at it, why not just always go all in and scalp short-term with full positions? Basically, he wasn't doing this for scalping profits. He wanted to build up a big (-ish) position and hold it for a long haul (10 or 20 points in ES, or at least a large percentage of the daily range.) He just wanted his basis to be a good one and he was willing to take some heat to get it.
Now, you may think that this is lunacy, but he was very successful at it. If someone thinks, "Well, he probably went broke because he's not posting here any more," the last time @michaelleemoore posted about the old group, he indicated that Ed is still trading and doing well. (He manages client money and decided he couldn't post trades publicly any more for professional reasons.)
I'm putting this up only to show that not everything has to agree with what's in the books, or what most traders do, or even what makes sense to you (or me.) It just has to work. ( ). "Work" means, work for the person who does it. Lots of things work for someone else that I can't use, after all....
(By the way, some time ago FT71 gave a demo in a webinar of how he scalped, taking a position to see what it would do and then going in and out as price moved with and against him. Basically, not too different in principle. I couldn't do that, either, and wouldn't want to try. There have also been a few people, many on the old spoos thread, including tigertrader and @Big Mike, who would scale into initially losing trades successfully as a way of establishing a position in a trade that eventually worked.... but overall we have seen only a few.)
As I have said before, I came down on "Never scale-in, period" in the poll, but that's just me. There's more in the world than just what makes sense to me, or what works for me, either. I can also appreciate something that doesn't work well for me, but not feel any need to do it.
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There have also been a few people, many on the old spoos thread, including tigertrader and @