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Break even and Partial profits. A Question for Scalpers.

The more tutoring I do the more a particular question keeps coming up: "why do you take partials and move your stops to break even so early in a trade"? While its always been part of my natural trading style as a scalper to take money off the table and bank it as soon as I can it is nevertheless a good question and one that merits some serious consideration. It is also a question that goes much deeper into how I trade. Articulating an answer will not only give me a stock answer to a question I´m always at odds to provide an elegant answer for, it will also provide a foundation for my scalping style and methodology. I always find writing or figuring out a problem on paper helps - so here goes!

First lets take a brief look at the traditionally understood types of trader you can be (obviously depending on your personal circumstances).

At one end of the spectrum is the Position Trader. This style of trading is typified by someone taking a position to capture the move via the longer term trend usually from an assessment of the underlying fundamentals and analysis conducted on the monthly and weekly (and sometimes) daily charts. The objective is to benefit from gains usually over weeks and months if not years and they are not concerned with fluctuations on the lower time frames. Position traders are similar to investors in this regard. There are numerous benefits to position trading not least that a winning trade will usually capture big gains. Similarly there are many drawbacks too such as being comfortable with potentially substantial drawdown and the fact that holding for long periods can open you up to shocks that are an ever present risk in all types of trading. There are many more pros and cons but its not my purpose to delve into them for the purpose of this article.

The next style in the time hierarchy is the Swing Trader. This is typified by taking a trade similar to the position trader but over a shorter term horizon. Swing traders are more technically oriented (as opposed to fundamental) and tend to look for trend change moves at the swing points on the daily charts (sometimes weekly) and will hold until the technical rationale for the trade has run its course or further information suggests the trade is nearing completion or about to reverse. Their time horizon is more based on the daily and weekly trend and will likely run for up to a month. Many traders fall into this category and it is a common style of trading for full time traders and I suspect that many if not most part time traders fall into this category. The pros and cons are similar to the position trader but less acute as more time is spent (usually) assessing the efficacy of the current trade on a daily basis.

We then have the Day Trader. Intra-day trading is a style of trading that tries to capture value (profit) from the vagaries of the chart movement on the lower time frame. It is similar to both the above in that intra-day traders (and scalpers - a subset of day traders) are looking for positions in minor swings on short time scales usually on the hourly charts and below. The objective, generally, is to enter trades with a maximum duration of a day (with no or few positions held over night) and profits taken whenever the view of the trader suggests that to do so would be a ´good idea´ based on any number of interpretations and readings of the intra-day price movement within the market.

The major advantage of intra-day trading and scalping is that risk can be ´micro´ managed or minimized (leading to increased control) and profit taken early (addressing the desire to make money quickly). But this needs to be balanced against the opportunity cost of not maximizing profits from long term trends.

Herein lies the basis of why I move stops and take profits early and also forms the crux of my overall trading strategy. What I am looking to do is to combine the benefits of micro managing risk and reward from scalping with the potential to capture larger moves from swing trading.

The key (for me) to doing this is to is to bank some partial profit early, reduce risk to break even at the same time and to leave a portion running in order to hopefully capitalize on bigger moves. In other words to take partials and move your stops to break even early in a trade!

While this concisely answers the question let me explain further. To do this we need to break my overall trading strategy down into 2 main parts

1 Entry and trade selection

2 Risk and trade management.

For the purpose of this article we will only cover the latter aspect. To show you how I select trades would take pages so you´ll have to take it as read that what I say on the subject is based on rigorous chart analysis resulting in a sound trade selection method.

Essentially to be successful as a scalper and capture larger swings at the same time I have established a trade management risk reward framework which combines

  • trade hit rate

  • initial profit target,

  • stop loss,

  • %age partial profit takes

  • incremental pips from ´runners´

As it It is quite a complex task to articulate the relationships between all the variables in written form, the table below summarizes my trade management plan using these key criteria.

The first input value to note is Hit Rate. This is determined from your success in selecting trades and as mentioned above is the core of the first part of my overall trading strategy. Whatever value input here will have a big impact on the final result. Obviously the better the hit rate - the better the result.

The second variable is the initial profit target. This is again largely determined by analysis of the price action based on the entry levels with the key being to select a level which is not so high as to be more easily achieved but not too low so as to limit your profit. My strategy is to use +10 as this gives me an ´optimum´ hit rate.

The initial stop loss is similar to the initial profit target in that it needs not to be so tight as to be easily ´hit´ but not so wide as to invalidate the balance of risk reward. The above table uses -7.

The %age used to determine the partial profit take is again a figure arrived at through analysis. The above table uses 75%.

The incremental pips gained from ´runners´ can be determined in a number of ways. The above uses the Average Daily Range (ADR) to set the limit. However in practice it is prudent to watch how the price action is unfolding as there may be more or less available than the pips at ADR and if you are prepared to hold over night, you may catch the bigger trends. You would only need to catch one long term trend to make this trade management strategy an overwhelming success! Alternatively you could limit your runner value to less with a view to capturing more of them. The above table also assumes that at a hit rate of 40 and 50% you do not catch a runner based on the fact that the more winners you get the better your chance of one of them ´running´.

In summary you can see that any combination of these key criteria can deliver x number of outcomes dependent on the input values - and I can already hear the questions many of you might have with the rationales I´ve used above. However, as my objective here was to answer a specific question i.e. why do I take profit and moves stop to break even early, I can only say that by taking partial profits at a set level, moving my stop to break even at the same time and leaving some ´on the table´, gives me a risk reward framework as set out above that achieves my desired goal as a trader: that of being a successful scalper and not losing out on the big swing trades. Having your cake and eating it - well... at least a slice of it!!