One key approach to scaling into successful trades is to add to winning positions once they’ve moved in the traders’ favor by at least one “Average Trading Range” (ATR) distance. For short term traders, we simply look at what a typical trading day’s high-low range looks like, then make trading decisions based on this information.
Adding To a Successful Trade: Determining Where To Enter
In Part 1 article of this series, we identified earlier long entries for Starbucks (SBUX) at 49.5 and again over 52.7. In Figure 1 [Starbucks (SBUX)], you can see that the bullish cup entry that we had identified earlier, at 52.7, continued on up by another 4 points after the article’s publication, on March 15th 2012. This strategy used a bullish cup breakout approach to identify the winning entry. The next strategy involves using the Average Trading Range (ATR) to determine where to add to a winning breakout trade.
In this approach, the trader begins by looking at a 15-day 15-minute candlestick chart, and identifies what the typical trading range on an average day may look like for the stock (or ETF) being traded. In Figure 1, you can see that this was identified as being roughly 1.0 point; by subtracing 52.7 from 53.7 on March 19th, 2012.
It is best to identify trading ranges to the nearest ½ point, for instruments in the $20-$70/share range, which are ideal for active traders. For cheaper stocks ($5-$20), rounding to the nearest quarter point (.25) is best. Armed with this data on price elasticity, the trader can now start to develop a practical, price-based trading plan.
If for example a trader had taken the 52.7 long entry signal on a breakout in the SBUX chart, the next step is to decide where to scale in, by adding more size to the trade. If no obvious bullish cup patterns are observed on the days following the initial trade entry, it’s a good idea to use the Average Trading Range (ATR) approach to help identify entries.
Step 1: Identify the Average Trading Range (ATR), based on a typical day’s price elasticity, as measured by the average high-low of a single trading day.
Step 2: Set an entry to add to a winning trade once it’s moved at least thirty-five to fifty cents (.35 - .5) above the trading range, past where the initial trade was entered. In this example, Figure 1, if an initial trade was taken at 52.7, a second entry would be indicated at 1.0 + .35 (1.35 points) above the day’s high on the day being watched, in this case that would be 53.7 + 1.35 = 54.05 for a secondary entry.
Step 3: From a risk management standpoint, now it’s important to set a hard stop at the breakeven price of the initial two trades. In this example, that would be ((53.7 + 54.05)/2) = 53.87 (round up, to 53.9 is fine).
Step 4: Adding to the current trade on subsequent 1-ATR price breakouts allows the trader to build up a larger position over time, for an in-trend moving stock (or ETF), while maintaining tight control over risk, for additional entries.
Step 5: Once a trade of at least a couple hundred shares has been built, by scaling into it, the trader can then use their discretion on when to start scaling back out of the trade, to lock in a potential profit. As a rule of thumb, if the trade has moved at least 4-5 Average Trading Ranges (ATRs) beyond the initial trade entry, it’s a good time to start tightening in the stops, to no further than 1 ATR behind the current trading price.
How to Develop a Process for Managing Multiple Entries
The best approaches are always the simplest, using unrealized P&Ls (unrealized profit-and-loss numbers), to manage several trades that a trader may be in during a sustained breakout. This is true for both day and swing trading approaches.
It’s a lot easier to keep an eye on a single brokerage interface with rows of numbers showing unrealized gains/losses, stops and exits, than to flip through many different charts. It then becomes more important to manage exits based on “the math” of how successful, or not, a given trade is, without being overly dependent on chart-based exit signals.
A good professional traders’ rule of thumb is to “scan with charts, but manage with P&Ls” once in several open trading positions. It all comes down to the numbers, since we’re trading to make as much profit as possible in our trades. When trying to decide how to enter and exit scaled-in trading positions, the numbers are ultimately much more important than specific chart patterns. A common error by retail traders is to let a trade go too far against them, simply because a support or resistance level is at a certain place.
From a professional’s perspective, it’s much more important to manage your trades based off your unrealized P&L numbers, keeping stops as tight as possible, and trading a wider variety of breakout trade entries. Trading solely off of chart patterns is an amateur’s approach; because the stop loss exits indicated may be far too expensive, using support and resistance or oscillation indicators. It’s much smarter to use the charts as initial scanning tools, but to then focus much more time and energy on the “math” of precision trading, by using focused scaling-in and scaling-out techniques.
Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus and is the founder of DaytradingUniversity.com, a popular online educational site for active traders.
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