"What type of trader are you? Are you a position trader, swing trader or day trader?” !fter trying a few different trading styles, we may answer, “I’m a swing trader.” Our decision as to what style of trading is often based on personal preference and our individual risk tolerance. Each style has its own benefits and drawbacks. For example, the benefit of trading like a day trader is that you are always flat (no positions) at the end of the session. Also, a day trader will get results every day, quick profits scalping the market. The downside to the day trader style is that they will never enjoy the possibility of a ten bagger (to steal Peter Lynch’s description of increasing your initial investment X10) like a position trader.  
 
On the other end of the trading style spectrum is the position trader. This style of trading involves keeping a trade on for weeks to months with the hope of capturing a major trend move. The benefits to this style of trading are obvious; it is possible as a position trader to have one of those windfall trades where you turn a $1,000 investment into $10,000. The downside to being a position trader is that often the risk on the stops is significant compared to a day trader who may have tight stops;and/or the position trader will have to lose several times in a row before they get the “windfall” trade.  
 
Then there are the moderate swing traders who fit neatly between the day traders and the position traders.  These ones like to hold on to a trade for a few days to perhaps a few weeks. These ones select the “middle way” (are Buddhists swing traders?!)/ moderate risk, moderate return.  

Most traders eventually find that the middle way of the swing trader suits them the best. However, as swing traders sometimes hold trades overnight, they may awake to see that the significant profit of the previous session has evaporated- “Oh, if only I was a day trader!” they may lament. Or sometimes a swing trader may liquidate a position after a few days only to notice that if he left the same position on for six months, he could have retired!- “Oh, if only I was a position trader!” If you have had these feelings, you are not the only one. The answer to this dilemma is to trade with the single in/scale out strategy. The single in/scale out strategy allows you to increase your return and reduce your risk at the same time!

The single in/scale out strategy allows you the flexibility to have different exit rules for each one of the contracts that you have bought or sold. The exit rules for one of the contracts will be “day trader” rules. With the day trader contract, you will quickly be in and out of the market, usually intraday, for a quick profit. Another contract will have “swing trader exit rules”- you will hopefully keep this position on for a day or two or longer to secure additional profits not obtained by the day trader contract. You will also have a contract that will have a “position trader” style of exit. Though this contract doesn’t pay out often, when it does, it is significant! I will sometimes refer to this contract as the lottery ticket contract.

The single in/scale out strategy works best when entering a position where you know what your initial risk is. If you use market orders with your trading strategy, you won’t know what your initial risk is until you get filled, even if your stop level is clearly defined. Ideally, we want to use limit orders and clearly defined stops when using the single in/scale out strategy.

Here are the simple rules for the single in/scale out strategy:

1. Buy or sell three contracts (or more in multiples of three) at your limit price. Use a single protective stop on all three contracts. The difference between your entry and your stop is your “initial risk”.

2. Calculate your first target. Your first target is 50% of your initial risk. Liquidate one position at this level. If you hit your first target, move your protective stop on the remaining two contracts in the direction of the trade by 50% of your initial risk. 

3. Calculate your second target. Your second target is 100% of your initial risk. Liquidate one position at this level. If you hit your second target, move your protective stop on the remaining contract to your entry point. 

4. Manage your last position with a trailing stop. Use a three bar trailing stop (more on this in the next issue) or some other volatility based trailing stop on your last contract as long as the trailing stop is not above (for short trades) or below (for long trades) your entry price. In other words, the worst case scenario with the last contract is getting stopped out at your entry price without a loss. Once you have one contract left, increase the time frame on the chart for your trailing stop. If you initiated your position on an intraday chart, change to a daily, if you initialted your trade on a daily chart,  change to a weekly..

Let's look at an example below in figure 1 of the single in/scale out strategy. In this example we have a bullish Gartley pattern on a daily chart of the AUD/USD spot Forex. We will be entering the position at the 78.6% retracement at .6910 and the initial protective stop is set to just below the beginning of the Gartley Pattern at .6760. The risk on this trade is theoretically set at 150 points per contract. As discussed, we will be buying three contracts so that means our initial risk for all three contracts is 450 points. Remember to keep within your risk parameters! Now that we have our risk defined, now we need to set our profit targets. To calculate your first profit target, simply subtract your stop price from your entry price. This price differential will define the initial risk per contract. The first target price is 50% of your initial risk. In the example below, the initial risk is 150 points per contract. The first target would be 50% of 150 or 75 points. If you add 75 to .6910, you get .6985 as seen on the chart. The second target is equivalent to 100% of your initial risk. Since our initial risk per contract is 150, we can calculate our second target by adding 150 points to our entry price of .6910 to give us .7060. If this sounds complicated, there is an easier way. In the Beck Toolkit for Market Analyst, there is a Single In/Scale out drawing tool that determines the levels described in this article with three clicks on the chart. These levels can be seen plotted below in figure 1.

Figure 1  Single In/ Scale Out Targets 

Let's assume that we have been filled at .6910 on the chart in figure 1. The worst case scenario after our fill would be that the market drops like a stone and we get stopped out at .6760 and lose 450 points. However, the likelihood of that event is low. Why? Because the most probable event in this situation is that the AUD/USD will hit your profit target first. The reason for that outcome is not due to the magic of the Gartley Pattern, but rather due to cold hard statistics. Once the position is filled at .6910, there is a higher probability that the market will trade at .6985 rather than .6760 due to the fact that the first profit target is half the distance from our entry price compared to where our stop is located. What this means is more often than not, we will hit our first target out of sheer randomness. Another reason why we should hit the first target before getting stopped out it due to an increase of volatility that usually accompanies a retest of a recent high or low. Usually, a market won't rip through significant support or resistance levels without first testing it. It is at this moment of uncomfortable indecisiveness that volatility will typically increase before a break or bounce takes place. Therefore, it is very common to hit the first profit target when this type of volatility is displayed at the completion of a Gartley Pattern at a 78.6% retracement level close to a previous high or low. 

Figure 2  First Target Hit 

As expected, we have hit our first target at .6985 in the chart above in figure 2. At this level we need to liquidate one of our positions with a 75 point profit. Our net position now is long two. Rather than leaving our stop down at .6760, we need to move it up 50% of our initial risk (150 X .5 = 75) or 75 points to .6835. We have now reduced our risk by 83%! Our risk on all three contracts initially was 450 points (150 X 3) and now it is only 75 points of risk. This 83% risk reduction after the first target is hit can be confusing the first time so let me explain. 

We've determined that the initial risk on all three contracts was 450 (3 x 150.) Then we took a profit of 75 points when we hit the first target. Now what is the risk on the remaining two contracts? By moving the stop up 75 points on the two remaining contracts, our risk on each of the contracts is 75 points, or a total of 150 point for the two of them. But the risk is not 150 points because we now have to subtract the 75 point profit that we have already made when we liquidated the contract when we hit the first target. When we subtract the 75 point profit from the 150 point risk that we have with the remaining two contracts, this gives us a risk on our overall position of 75 points if we get stopped out at .6835. A 75 point loss is a lot better than a 450 loss! - and as discussed earlier, hitting our first profit target is a high probability event!  

Now that we have hit our “day trader” target at .6985, our focus is on our second profit target at .7060. The second profit target is always 100% of our initial risk (150 X 1), or in this case 150 points above our entry price of .6910.

Figure 3  Second Target Hit  

As seen in figure 3, we now have hit the second profit target at .7060 and it’s time to liquidate our second “swing trader” contract at this level for a 150 point profit. Just as we moved the stop up 75 points when we hit the first profit target, we need to do the same now that we have hit the second target. Rather than leaving the stop down at .6835, we move it up by 50% of our initial risk (150 X .5) or 75 points to .6910 which happens to be the price that we bought all three contracts at. We are now in a very comfortable position. We have locked in a 225 point profit and our protective stop on the remaining contract is at the same price that we entered. Now we have one contract left, we are left with our long term “position trader” contract. !s such, we need to use a big, loose position trader style of stop on this contract. I refer to this contract as the lottery ticket contract because it doesn't "pay out" as often as the other two contracts do. However, when it does work, you will remind yourself that the few times in a year that you win the “lottery,” it was well worth the time managing your multiple contract positions. In the next issue of The Educated Analyst, I will show you how to manage your “lottery ticket.”

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