Why You WILL Go Broke Taking a Quick Profit
When you scalp, you lose. Here’s Why…
The art of scalping is becoming more and more difficult. Dominated by large volume, high frequency trading firms, these firms have the ability to trade huge size in fractions of a second.
Without getting into the technical jargon these high big firms can get in and out of the markets lightning fast because they co-locate their servers (house them right next to the exchange servers) giving them the fastest fills possible and least amount of latency.
How to Identify YOUR Advantage (Trading Edge)
Whether you call yourself a retail trader, at home trader, or independent trader the advantage we have is the ability to ride the coat tails of these big players. In trading smaller size (relative to the big firms) we can jump in and be taken along for the ride to meaningful profits. The trick is to not fall victim to the bandwagon effect.
Looking at the E-mini S&P, I consider anything under 1 point ($50 per contract) scalping. Typically you need a market to trade through your order to get filled so in order to profit 1 tick ($12.50) you really need the market to have a trading range of 3 ticks.
Taking quick, small profits lead to insurmountable odds. The goal here is to profit in the form of multiple points, targeting a reward to risk ratio of 3:1 with the expectation that some of our trades will result in larger winners.
(More information related to my own trade setups can be found under the ‘trading rules’ tab at the top of the page).
How to Put the Odds in Your Favor
A Football Analogy
As a trader you are like an offensive player in football. You get multiple attempts to carry the football and try to score a touchdown; your objective is to take the trade it as far as possible. 3:1 reward/risk ratio should be your target. In doing so, you can be right less than 50% of the time and still make money.
For those that don’t know much about the American game of football here’s a quick overview:
Players charge down a 100 yard field trying to get to the ball into the end zone. They get four downs (attempts) in which to move the ball forward at least 10 yards. This leads to a rest of downs (another 4 tries). If they can’t move the ball forward 10 yards in these 4 attempts they give up possession to the other team. In other words first downs lead to touch downs.
In trading, just like in football you get multiple opportunities to score. It is your job as a trader to try and maximize these opportunities. We must use money management techniques like scaling out of our positions and trailing our stops to prevent us from going backwards.
Which Has More Value?
It’s not about how many plays you run (trades you take) it’s about scoring touchdowns and getting the most out of each trade.
Take two players…
#1 has 20 carries for 100 yards and 0 touchdowns
#2 has 10 carries for 50 yards and 1 touchdown.
Player #2 is clearly more productive in scoring meaningful points. While each yard gained is of value, it’s the touchdowns that have the biggest impact on winning the game.
Quick Profits Lead to Losing in the Long-term
Unless the market immediately rips in your favor, taking quick, small profits is not sustainable over the long term. Instead of taking quick profits, execute patient and focus on trailing your stop.
How many times do you find yourself saying “if I just left my profit target where it was and didn’t mess with the trade it would have worked out and been a big winner?” Leave your profit target alone, manage your stop.
A football player always trying to break through tackles going for the touchdown. As a trader you should be doing the same. Put emphasis on getting the most out of each trade. Don’t exit the trade early for a quick (and small) profit. If you must do something focus on managing your stop and leave your original profit objective where it was.
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