Over the last two days I have been working through a multi-part query which came in from a trader over the weekend. Monday’s post was about mini stock index contracts. Tuesday’s was on the subject of long timeframe trading. Today the question focuses more on building positions.
The idea I have in mind is to try to build a sizable position over time by regularly adding to a winning trade. Can it be done or should I be thinking differently? Would it be done by buying the pullbacks (uptrend) / selling the rallies (downtrend)? In terms of controlling risk, what should be the limit to the size of such a position, as a percentage of account size? Should the initials stops be moved and the size of the stop order adjusted as the trend progresses, or does one place new stops for each additional trade?
In order to really properly answer this particular set of questions, on first needs to answer the high level question of whether we’re talking about trading here or about the long-term accumulation of wealth via the stock market. The former suggests moving in and out of the market, while the latter is more inclined toward staying in and progressively adding to the position over time.
The reason one needs to make that differentiation is because each approach implies a different type of strategy. There are those strategies which would be employed in the case of a trading mindset and others which would be used in the accumulation one. Since the focus of this blog is to discuss trading concepts, I’ll approach these questions from that perspective.
The idea of adding to winning positions is one which gets discussed quite frequently. Some folks take the view that if a position is worth taking at all, it’s worth going in at full size, not scaling in (so to speak). Others take the view that adding to winners is a great way to really make big gains when you have a move with the potential to work very nicely in your favor.
Really, I think a lot of whether you go with the all in vs. the scale in approach depends on how you manage the risks and whether you can tolerate the potentially wide swings in equity. The risk side of things has been talked about at length, but I think few folks really consider the implication of drawdowns and large movements in the profitability of their trades (or portfolio). When you start adding to a position you increase the size of the swings both in currency terms and in terms of the percentage of the total account value. Trending markets can move widely. Make sure you can handle what that’s going to mean to your positions as you sit through it.
As for the specific strategies of adding on retracements of the base trend, that’s a very good one. There are two requirements, though. First, you need to have something in place which tells you when it’s no longer a retracement, but an trend cessation. Second, you should have a clear set of criteria or strategy for doing those retracement additions, both in terms of timing and size. If at all possible, running some backtests with different position sizing and exit (stop) strategies to help do that could help considerably.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
