At some point just about every trader starts pondering the question of if, when, and how to add to winning positions. After all, part of trading success is getting the most out of your winners, while of course also minimizing the impact of your losers. Let’s look at the two primary strategies for doing so.
Start Small & Build
One approach some trading take is to start with an undersized position when first entering a new trade. For example, if they would normally look to risk 3% on their trades they might start off with only 1% exposed. The idea here is that any given trade could be profitable, and they don’t want to miss out all together, but that they want to see some kind of confirming move from the market before moving up to a full-sized position, or expect to see a counter move that could be used to get a better price.
This approach is often referred to as scaling in. Traders who find themselves often getting in too early on a market turn (like a change in trend) can benefit by this approach because it makes sure they are in should the entry not be too early after all (ensuring some profit), but allows them to move the remainder of the position in at potentially an even more attractive entry point.
This approach generally isn’t great for a strategy where trades tend to be immediate winner or loser types, meaning the market either takes off in favor of the trade or it moves directly against it to get stopped out. It can, however, be very good where there’s some kind of secondary confirmation that the trade is likely to be a winning one. For a chart based trader that could be something like seeing a higher low when in a long position.
Doubling Up, etc.
The other way traders look to add to positions is to use the profits from a winning trade to expand their position. This is particularly the case in markets like futures and forex where gains from open positions are immediately available to be used as margin for new trades. For example, if a trader is long an S&P 500 e-mini contract and the market rises 20 points, they have an extra $1000 in available margin money in their account. That may let them expand their position by doubling up (depending on how much they had in the account in the first place).
Needless to say, adding to winners should be based on a well-defined methodology and not just done willy-nilly.
Your Position Adding Mindset
Doubling up or otherwise adding to positions that are already what would be considered “full-sized” requires a clear mindset when thinking about what it does to your risk. Basically, it comes down to whether you are going to think in terms of risk on your original equity, or risk on your running equity (original plus open position gains).
Generally speaking, if you take the former view you are going to be willing to be more aggressive when it comes to adding to positions because you will in essence see it as playing with house money. That is all well and good as it can definitely make for some really big winners. Be aware, though, that it can lead to major equity swings as the over sized positions moved up and down (a position of 2x is going to move twice as fast as one of 1x). In some cases big gains are going to be wiped out very quickly because of a price reversal. That can be extremely deflating, so the trader needs to balance things out to have the drawdowns at psychologically (and bottom line profitability) acceptable levels.
Traders who look to running equity as the basis for risk assessments will be taking a much more conservative approach. They will be much less likely to add to trades in large chunks because it would generally exceed their risk parameters. For example, if a traders uses 2% as their risk threshold, they start with $10,000, and have $1,000 in position profits their permissible risk on the trade will be $220. That’s only 10% higher than what it was at the start of the trade. Is that enough to be able to add to the position? Probably not.
While it might sound like the “playing with house money” mindset is likely to be the more profitable, it doesn’t make it the right or better one. It’s a much more volatile approach and as such one not suited for many traders. The first time you see a big gain wiped out in a blink because of the bigger size you will know what I’m talking about.
Test, test, test
Adding to positions isn’t something that should be done randomly. You should have a strategy for doing so, both in general terms and on a trade-by-trade basis. Know what your strategy is go in. Test the strategy out with different variations so you know what will work for you and what won’t. That way, when the time comes to add that extra contract or lot or whatever, you’ll be comfortable in doing so with the knowledge of what to expect.