Why scaled exits make sense

Discussion in 'Risk Management' started by rnaugin, Jun 13, 2009.

  1. rnaugin


    I've been thinking about scaled exits lately and wanted to share my thoughts. Initially I decided that scaled exits were not useful. Later I decided that they can be very helpful. Please let me know if you think this is accurate.

    Many apparently successful traders advocate scaled exits.

    Testing scaled exits reveals that they are the equivalent of trading multiple strategies at the same time, each with different exit criteria.

    The obvious question arises, why not just trade whichever strategy is better performing? This leads some traders to conclude that scaled exits generate sub par returns.

    Lets assume that two strategies are in use, both having the same initial stop loss. One takes a conservative profit when it first becomes available, while the other accepts retracements all the way back to breakeven after the first target is reached.
    Furthermore I'm ignoring scalping and swing trading, and just focusing on trend capture strategies.

    The naive answer is that which strategy generates better returns may alternate, and combining them smoothes out the equity curve. But frequently it can be shown that one of the two strategies will almost always have a higher return.

    The more important reason is that the highest return strategies tend to be the ones with the largest retracement stops, more distant targets and lower success rates. If you are willing to accept a retracement from a nice, safe profit back to breakeven, then you can occasionally bag much larger moves. But it's not pleasant to suffer long periods of losses or breakeven in order to capture the occasional very large gain.

    Combining the two different exits gives the psychological comfort and predictability of more often bringing home a small profit, while simultaneously improving overall returns with an occasional windfall.
  2. rnaugin


    Never mind, I see I just missed a long thread about scaling out where all this stuff was discussed at length which much greater insight than what I could muster.

    Moderators could you please kill this thread? thanks.