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In today’s episode, you’ll discover how to average into your winners (without destroying your open profits).
So tune in right now…
Resources
The Complete Guide to Risk Reward Ratio
How to Trade Pullbacks Like a Pro
The Essential Guide to Momentum Trading
Transcript
Hey, hey, what’s up my friends? Welcome back to today’s episode.
In the previous episode, I spoke about how to average into your losers. So today I’m taking things in the opposite direction – how to average into your winners.
Averaging into your winners simply means that you buy more shares or the assets you’re trading, as the price moves in your favour. But before I talk about how to do it, I want to firstly share with you how not to do it.
Avoid this mistake when averaging into your winners
Many traders get overly excited. Let’s say they’ve bought some shares of Amazon at $50. When the price goes up a little, they want to buy more as they thought, “I know that the market is moving up higher with a strong momentum. Let’s buy to make more money.”
The problem with this is, although the market is moving in your favour, but if you buy or scale into your winners too early, then when a pullback comes, you might lose more than you expected.
For example, let’s say you have 1,000 shares of Amazon at $50. Then as it moves up to $51, you buy another 1,000 shares. Now you’re holding 2,000 shares of Amazon. But if Amazon drops by $1, that’s a loss of potentially $2,000 to you.
So be careful with averaging into your winners too early. So how should you go about it?
Let me share with you a few things to take note of.
1. Scale in with 2R in open profits as a buffer
Let’s say you bought some shares of McDonald’s at $40, and you have a stop loss at $35. Your risk when trading McDonald’s is $5 per share.
Profit of at least 2R means that you want to make at least two times your initial risk. If your risk is $5, two times your initial risk will be $10. McDonald’s has to go up to at least $50, from $40 to $50, before you consider scaling into your winners.
The reason for doing that is because now you have some open profits as a buffer. If the market does reverse against you or make a pullback, you have open profits to play with. And that’s very important.
When you want to average into your winners, you want to make sure that you have some buffer of open profits before you even consider it. That’s the first thing.
2. Scale in with less than one-third of your initial position
Just because you have open profits doesn’t mean that you won’t lose money. Because, as we have discussed earlier, if the market moved against you, you are now holding an even larger position size so you still must be careful with how many shares you buy.
Let’s say initially you bought 1,000 shares of McDonald’s at $40 and now, McDonald’s is trading at $50 a share, you’re up with a profit of 2R and you want to buy more shares of McDonald’s, or how many shares should you buy?
A general guideline I have for you is this, try not to risk more than one-third of your initial position. If initially you bought 1,000 shares of McDonald’s, your second tranche to scale into winners and buy more McDonald’s shares should not be more than one-third of your initial position size.
That means that now you shouldn’t buy more than 333 shares of McDonald’s. The reason for this is simple.
When you scale into your winners, you want to imagine it like a pyramid where your base is your initial position size of 1,000 shares. As the share price moves in your favour, you want to add in a smaller position size relative to the first position you had.
So if the market does a pullback, you can still withstand it because your average share price is still lower than after the pullback since most of your positions are bought on the first attempt, at the first tranche.
When you average into your winners, you want to reduce your size, not put in the same size or even more because when a slight pullback comes it’s gonna be painful and you will be hurt.
The third and final thing is this…
3. Scale in during a pullback
Why scale in on a pullback? Because that’s where the market could start to reverse up higher. And when you see it reverse up higher, you now have a new swing low or a swing point on your chart to reference from and set your stop loss. Does it make sense?
If that swing low or swing point is broken, you can exit all your positions. Compared to chasing a breakout and scaling in your winners, if the market breaks out higher, there could be no relevant point to set your stop loss or it could be very far away from your initial entry price.
If you scale into your winners on a pullback, you can reference that recent swing low to set your stop loss for all the positions that you have, for all the different entry points that you had earlier. And for all the subsequent attempts at scaling in, you can simply reference that most recent swing low.
Here’s a quick recap…
Recap
If you want to scale into winners:
- Have a buffer of at least 2R of open profits
- Scale in with a reduced position size to have a more stable base (recall the pyramid structure that I mentioned)
- Scale in on a pullback. This is where you can take advantage of the next potential swing that comes up higher. And if it doesn’t occur at least you have a new reference swing point to set your stop loss for all the trades that you have scaled in so far
With that said, I’ve come towards the end of today’s episode. I wish you good luck and good trading. I’ll talk to you soon.